Image Source: Mike Mozart
Let’s take a look at the earnings reports of some of the largest consumer staples companies. Margin performance left a good deal to be desired across the space as transportation and raw material costs are largely on the rise, and organic growth trends could be better. Companies included: Kellogg, Kraft Heinz, Kimberly-Clark, and Colgate Palmolive.
By Kris Rosemann
Macroeconomic uncertainty stemming from geopolitical tensions and potentially slowing economic growth in emerging markets have played a role in stagnant top-line growth for consumer staples entities of late, and ongoing pricing and promotional battles are not likely to go away anytime soon as the proliferation of the convenience of online shopping has brought about a new era in consumerism. As a result, advertising and promotional spend increases are needed to drive organic growth, but the margin impact of such spending is weighing on profit levels due in part to stagnant organic growth. Commodity inflation has returned in a notable way in 2018, and rising costs for raw materials, packaging, and transportation (overhead) are also eating into profit margins. Once tax reform benefit laps, bottom-line growth may only become an increasingly tough uphill battle for consumer staples entities.
We’re not seeing many attractive valuation opportunities within this group at the time, especially given expectations for largely muted growth, but many investors may be more interested in the space due to the competitive dividend yields found throughout. Shrinking margins and meager organic growth prospects are not ideal for robust dividend growth ideas, which we like to have cash-rich balance sheets and significant and growing free cash flow streams. With that said, let’s dig in to the third quarter reports of a number of big name consumer staples entities to get a better feel for what’s taking place in their businesses.
Kellogg Slashes Profit Guidance
Snack and breakfast cereal giant Kellogg’s (K) third-quarter 2018 report, released October 31, revealed ongoing stagnation in terms of organic growth as organic net sales advanced 0.4% from the year-ago period, while the acquisition of RXBAR in October 2017 drove reported net sales growth of 6.8%. Management pointed to a rationalization of stock-keeping units in its ‘US Snacks’ business as part of its transition from a direct-store delivery model, as well as price adjustments as reasons for the muted growth. Adjusted operating profit declined 4% in the quarter on a year-over-year basis due to an increase in advertising and promotional investments and higher distribution costs; overhead reduction associated with the transition away from the direct-store delivery model was not able to offset rising costs such as transportation and new packaging investments. Adjusted diluted earnings per share rose 3% in the period to $1.06 from the third quarter of 2017 thanks to a materially lower tax rate.
Along with the rather uninspiring quarterly report, Kellogg made a number of adjustments to its full year guidance, including raising net sales guidance to 5% on a currency-neutral basis from 4%-5% previously. However, the company lowered its adjusted operating profit growth guidance to roughly flat on a currency-neutral basis from prior growth guidance of 5%-7% due to increased investments and continued mix shifts, and adjusted earnings per share growth guidance followed adjusted operating profit guidance lower to 7%-8% on a currency-neutral basis from 11%-13% previously. Management continues to expect to generate $1 billion in free cash flow in 2018, which should be sufficient in covering annual cash dividend obligations given the pace of the payout through three quarters.
Kellogg’s net debt load was $8.6 billion at the end of the third quarter, and free cash flow through the first nine months of 2018 of $537 million came up short in covering cash dividends paid in the period of $568 million. The company’s Dividend Cushion ratio leaves a lot to be desired at 0.2, and shares yield ~3.6% as of this writing. Our fair value estimate for Kellogg currently sits at $64 per share.
Kraft Heinz Reports Organic Growth Despite Negative Pricing
Kraft Heinz (KHC), the fifth-largest food and beverage company in the world, reported third quarter earnings November 1, which revealed organic net sales growth of 2.6% on a year-over-year basis as volume/mix rose 3.5 percentage points thanks in large part to consumption growth in a majority of categories in the US. Pricing provided a 0.9% top-line drag as higher promotional activity and key commodity-related pricing actions more than offset increased pricing in international markets, the latter of which was driven by inflationary environments. Adjusted EBITDA in the quarter fell 14.4% from the year-ago period due to investments in strategic capabilities and higher overhead and input costs easily offset organic net sales growth. Adjusted earnings per share declined 6% on a year-over-year basis to $0.78 as a lower tax rate was not enough to offset the declines in adjusted EBITDA.
Management pointed to a more normal bonus incentive compensation accrual in 2018 compared to the previous year, in which it was a relatively more favorable impact, as a driver of its lower adjusted EBITDA performance, a factor that was anticipated, but commodity inflation also played a role in the profitability weakness. Moving forward, the company expects adjusted EBITDA growth and the absolute level of EBITDA to begin improving in the fourth quarter of this year. Thanks in part to the higher levels of investment of late, Kraft Heinz expects to carry the organic net sales growth momentum it has experienced through the rest of 2018 and into 2019.
At the end of the third quarter of 2018, Kraft Heinz had a net debt load of just over $31 billion, and the company’s free cash flow generation continues to come up short in covering cash dividend obligations, which results in the company’s poor Dividend Cushion ratio of -0.1 (negative 0.1). Our fair value estimate for shares currently sits at $57 each, and shares yield ~4.9% as of this writing.
Kimberly-Clark Lowers Organic Growth, Operating Profit Guidance
Consumer staples giant Kimberly-Clark’s (KMB) third quarter 2018 report, released October 22, revealed organic sales growth of 1% on a year-over-year basis as net selling prices and product mix both improved by 1% but were partially offset by a 1% decline in volumes, while reported sales fell 2% due to the negative impact of currency headwinds. The company is in the midst of a global restructuring program that is expected to deliver annual pre-tax cost savings of $500-$550 million by the end of 2021 via workforce reductions and manufacturing supply chain efficiencies, but its margin and operating profit performance has left a lot to be desired of late as adjusted gross margin contracted by 250 basis points in the third quarter from the year-ago period due to higher pulp and raw materials costs. Adjusted operating profit declined 8% on a year-over-year basis in the quarter due to the aforementioned gross margin contraction and higher input costs, but adjusted earnings per share advanced 7% thanks to a lower tax rate, lower interest expense, and a lower share count.
Kimberly-Clark now expects full-year 2018 net sales to be roughly flat from 2017, which is down from previous guidance ranges of flat to 1% growth and 2%-3% growth. Its anticipated adjusted operating profit decline is now expected at or slightly higher than the top end of its prior guidance for a 2%-5% decline, and commodity inflation for the full year is now expected to be in the upper half of the company’s previous guidance of $675-$775 million. Adjusted earnings per share guidance was reiterated in a range of $6.60-$6.80.
Through the first three quarters of 2018, Kimberly-Clark generated nearly $1.5 billion in free cash flow, which is roughly flat with the comparable period of 2017 and sufficient in covering cash dividends paid in the period of just over $1 billion. However, it holds a net debt load of just over $7 billion, which plays a role in its Dividend Cushion ratio currently being just above parity at 1.1. Our fair value estimate for shares sits at $102 each, and shares yield ~3.6% as of this writing.
Organic Sales Fall at Colgate-Palmolive
Leading global consumer products company Colgate-Palmolive (CL) reported third quarter earnings October 26, and its top-line growth left investors unimpressed as organic sales fell 0.5% on a year-over-year basis. Market volatility in Brazil and trade inventory reductions in China also played a role in the top-line weakness. Net sales in the quarter dropped 3% from the year-ago period as unit volume was flat, pricing advanced 1%, and currency headwinds provided a 4% drag. Gross profit margin contracted 120 basis points from the comparable period of 2017 as higher raw material and packaging costs were only partially offset by cost saving initiatives and higher pricing, and operating profit margin fell 140 basis points due to the aforementioned gross margin pressure and an increase in overhead expenses and advertising investments.
Reported diluted earnings per share in the quarter fell to $0.60 from $0.68 in the year-ago period due in part to charges related to efficiency initiatives and US tax reform, but the company continues to expect double-digit earnings per share growth in 2018 on a year-over-year basis despite expectations for gross margin contraction. Free cash flow generation through the first nine months of the year fell 2% from the comparable period of 2017 to nearly $1.9 billion, which was well in excess of cash dividends paid in the period of just over $1.1 billion.
Colgate-Palmolive holds a net debt position of nearly $5.8 billion as of the end of the third quarter, and its Dividend Cushion ratio currently sits at a reasonable 1.6. Our fair value estimate for the company is $58 per share, and shares yield ~2.7% as of this writing.
Food Products (Small/Mid-Cap): CALM, DF, FLO, FDP, HAIN, HRL, JJSF, LANC, MKC, SJM, THS, TSN
Food Products (Large/Mid-Cap): ADM, BG, CPB, CAG, GIS, HSY, K, KHC, MDLZ, NSRGY, UL, UN
Household Products: CHD, CL, CLX, ENR, HELE, KMB, JNJ, PG
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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.