Image source: Procter & Gamble fiscal second quarter presentation
Procter & Gamble and Kimberly-Clark reported calendar fourth quarter earnings January 23, and both were able to deliver organic sales growth in the period. Commodity cost inflation and currency weakness are key headwinds to keep an eye on moving forward as they have weighed on margin performance, particularly at Kimberly-Clark as Procter & Gamble reported impressive productivity cost savings.
By Kris Rosemann
Consumer staples giants Procter & Gamble (PG) and Kimberly-Clark (KMB) are working to offset the impact of input cost inflation with pricing power and cost saving and productivity initiatives. Currency headwinds have proved to be a material drag on reported sales growth of late, but both companies were able to deliver positive organic top-line growth in the calendar fourth quarter. Kimberly-Clark is expecting 2019 to remain a challenging, but potentially improving, operating environment, and Procter & Gamble will be impacted by many of the same factors. Relatively speaking, we like how Procter & Gamble has been able to navigate its fiscal 2019 (ends June 30) thus far, particularly in terms of operating margin thanks to notable productivity cost savings. We’re not looking to add exposure to either company in either simulated newsletter portfolio.
Procter & Gamble Raises Fiscal 2019 Organic Sales Guidance
Procter & Gamble turned in another quarter of solid organic sales growth in its fiscal 2019 second quarter, results released January 23. Organic volume growth of 2%, positive mix impact of 1%, and pricing growth of 1% all combined to drive organic sales growth 4% higher on a year-over-year basis, but reported net sales came in roughly flat as a result of a 4% drag from unfavorable foreign exchange rates. Management noted that it has not seen a slowdown in China and is “fairly confident” on its prospects in the country in the back half of its fiscal year, and e-commerce sales growth in the 30% range helped drive organic sales growth in its fiscal second quarter.
Procter & Gamble’s gross margin performance continues to be impacted by rising commodity costs, among other factors, as core gross margin on a currency-neutral basis contracted 20 basis points from the year-ago period. Productivity savings and pricing benefits were more than offset by commodity cost increases, innovation reinvestments, and unfavorable product mix on the gross margin line. Core operating margin on a currency-neutral basis expanded 80 basis points from the comparable period of fiscal 2018 thanks to material productivity cost savings, but the reported figure was impacted by negative foreign exchange rate impact (90 basis points) and non-core restructuring charges (10 basis points). Core earnings per share came in at $1.25 in the quarter, up 5% on a year-over-year basis, thanks in part to a lower tax rate.
Solid bottom-line performance at Procter & Gamble translated to the cash flow statement in the first half of fiscal 2019, as cash flow from operations advanced 3.5% on a year-over-year basis. Disciplined capital spending in the first six months of the fiscal year helped drive free cash flow generation to ~$5.8 billion, up nearly 7% from the year-ago period, and cash dividends paid in the period came in at $3.7 billion. At the end of its fiscal second quarter, the company held a net debt position of ~$21.5 billion ($33.6 billion in total debt versus $12.1 billion in cash), and this lofty debt load, which has grown in the first six months of fiscal 2019 as a result of acquisitions, has an impact on its Dividend Cushion ratio, though the ratio was relatively solid as of the end of fiscal 2018 at 1.8. Shares yield roughly 3% as of this writing.
Management raised the upper bound of its fiscal 2019 organic sales guidance by 1% following the second quarter to a range of 2%-4%, but foreign exchange rates are expected to provide a 3%-4% headwind with a modest impact to the reported sales figure coming from the net impact of acquisitions and divestitures. Procter & Gamble also reiterated its guidance of 3%-8% growth in core earnings per share in the year over $4.22 in fiscal 2018, and that growth target includes an estimated $1.4 billion headwind from currency and higher commodity and transportation costs. The company expects to exceed its target of 90% adjusted free cash flow productivity (ratio of free cash flow to net earnings).
While we credit Procter & Gamble for turning in solid organic sales growth as it returned to slight pricing growth, which was a key piece of is strategic rationale in its recent massive portfolio transformation, in its fiscal second quarter, we’re not interested in highlighting shares in either simulated newsletter portfolio at this time. Potential headwinds not included in its explicit guidance ranges include significant deceleration of market growth rates, significant currency weakness, further commodity cost increases, and further political and economic volatility. Shares are trading near the upper bound of our fair value range.
Kimberly-Clark’s Margins Contract; Expects Challenging but Improving Environment
Kimberly-Clark reported organic sales growth of 3% in the fourth quarter of 2018, results released January 23, as net selling prices advanced 3% from the year-ago period, and reported sales dropped 1% on a year-over-year basis as a result of the negative impact of foreign exchange rates. Adjusted operating profit, which excludes charges such as those related to the 2018 Global Restructuring program1, dropped nearly 13% in the quarter from the year-ago period as higher net selling prices and cost savings were easily eclipsed by higher input costs. Foreign exchange rates and higher advertising spending also weighed on the operating line in the period, which ultimately resulted in a ~230 basis point contraction in adjusted operating margin, and GAAP earnings per share were shellacked by the aforementioned pressures and one-time charges.
Cash provided by operations in the full year 2018 at Kimberly-Clark advanced slightly to nearly $3 billion, which helped limit the decline in free cash flow in the year to ~2.4% as capital spending rose nearly 12% on a year-over-year basis. Free cash flow came in just under $2.1 billion in the year, which was more than sufficient in covering cash dividends paid of ~$1.4 billion. We like what we’re seeing in terms of free cash flow coverage of dividends, but the company’s net debt load of $6.9 billion (~$7.5 billion in total debt versus $539 million in cash) weighs on its Dividend Cushion ratio, which currently sits at parity, or 1. Shares yield ~3.6% as of this writing.
In 2019, Kimberly-Clark expects organic sales growth to continue to be driven by price increases with guidance coming in at 2% over 2018 thanks to 3%+ projected growth in net selling prices. Foreign exchange rates are anticipated to have a 3%-4% negative impact, and divestitures in conjunction with the 2018 Global Restructuring Program will reduce reported sales slightly. Adjusted operating profit is expected to grow 1%-4% in 2019 as cost savings are expected to be at least partially offset by key input cost inflation, especially in international markets. Adjusted earnings per share guidance comes in a range of $6.50-$6.70 compared to $6.61 in 2018, and capital spending is expected to rise to $1.1-$1.3 billion from $877 million in 2018 due in part to significant spending related to the 2018 Global Restructuring Program, suggesting free cash flow may face pressure in the year.
In its fourth quarter report, Kimberly-Clark revealed its K-C Strategy 2022 plan. The plan’s three growth pillars are to elevate core businesses, accelerate growth in developing and emerging markets, and drive digital marketing and e-commerce. The company will focus on improving margins and funding growth initiatives by improving supply chain productivity, executing its 2018 Global Restructuring Program, and closely controlling discretionary spending, and it expects annual capital spending to settle in a range of 4%-5% after the restructuring program is completed. Financial objectives associated with the K-C Strategy 2022 plan include 1%-3% sales and organic sales growth, mid-single-digit annual growth in adjusted earnings per share, which should be roughly followed by similar dividend growth, and the maintenance of adjusted return on capital at least at current levels.
We’re not looking to add exposure to Kimberly-Clark as the company is likely to continue facing a challenging operating environment. Management projects improving margins, which isn’t saying much after a poor showing in 2018, but headwinds from commodity costs and currency will persist. Shares are currently changing hands in the upper half of our fair value range, the midpoint of which sits at $102 per share.
Household Products: CHD, CL, CLX, ENR, HELE, KMB, JNJ, PG
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1) In January 2018, Kimberly-Clark initiated the 2018 Global Restructuring Program in order to reduce the company’s structural cost base and enhance the company’s flexibility to invest in its brands, growth initiatives and capabilities critical to delivering future growth. The program will make Kimberly-Clark’s overhead organization structure and manufacturing supply chain less complex and more efficient and is expected to broadly impact all of the company’s business segments and organizations in each major geography.
The company expects the program will generate annual pre-tax cost savings of $500 to $550 million by the end of 2021, driven by workforce reductions along with manufacturing supply chain efficiencies. As part of the program, Kimberly-Clark expects to exit or divest some low-margin businesses that generate approximately 1 percent of company net sales. The sales are concentrated in the consumer tissue business segment. To implement the program, the company expects to incur restructuring charges of $1,700 to $1,900 million pre-tax ($1,350 to $1,500 million after tax) by the end of 2020. – Source: KMB quarterly report
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.