Investors can certainly make good money investing in well-run personal care companies with solid brands. Along those lines, names like Procter & Gamble (NYSE:PG), Colgate-Palmolive (NYSE:CL), Unilever (NYSE:UN), and Kimberly-Clark (NYSE:KMB) have all delivered very strong capital gains over the past year. In the case of Kimberly-Clark in particular, though, I do worry that this consumer staples melt-up has gone a little too far. I do like the company's growth potential in emerging markets, but commodity inflation could threaten further margin improvements and I believe the stock is too expensive relative to its growth prospects.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

On-Target Growth And Strong Margins In The First Quarter
Kimberly-Clark helped its case with a strong first quarter result. Revenue rose less than 2% on a reported basis, but organic revenue growth was in excess of 3% despite a challenging year-ago comps. Growth was led by the consumer tissue business (a lucrative cold/flu season) which rose nearly 4%, while the personal care business was up more than 2%. KC Professional revenue was up slightly, while organic health care revenue was down 2%.

As mentioned, margins were surprisingly strong this quarter. Adjusted gross margin improved about 140bp and beat the sell-side average by about 80bp. Likewise, adjusted operating income was considerably stronger than expected, as it increased 16% and beat expectations by about 8%. All told, about half of the company's beat relative to the average EPS estimate can be tied to operating outperformance.

SEE: Understanding The Income Statement 

Brand Strength Versus Pricing Pressure
One of the curious things about the recent strength in consumer stocks is that it is coming in the face of relatively weak pricing and volume trends. Consumers tend to be pretty loyal when it comes to products like toilet tissue and facial tissue, but private label brands (particularly at retailers like Walmart (NYSE:WMT) have been picking up quite a bit of share over the past couple of years.

Now maybe the Street believes that these companies are past the worst of that share loss to private label, and that enhanced promotional activities will restore share growth. I'm not so sure. Between Nielsen data and consumer surveys, it sounds like shoppers are increasingly price conscious and that could become a larger problem for Kimberly-Clark if and when input costs start to rise again.

In the meantime, it will be interesting to see how rivals like Procter & Gamble and Johnson & Johnson (NYSE:JNJ) choose to compete against Kimberly-Clark. Nobody seems eager to surrender any margin and there hasn't been much price competition among the major branded players – something that could arguably play into the hands of the private label manufacturers.

International Is Still A Bullish Story
A big part of the bullish thesis on Kimberly-Clark has been its above-average growth potential in emerging markets. Few personal care companies have a larger emerging markets business than Kimberly-Clark (Colgate would be one of the exceptions), and the company has definitely benefited from the growth in consumer demand for products like disposable diapers, facial tissue, and toilet tissue.

Still, these products aren't so entrenched that constant sales growth is a given. Against some difficult year-ago comps, Kimberly-Clark saw international sales up just 4% in consumer tissue (in constant currency) and 6% in personal care – not bad, I'll grant, but certainly weaker than the year-ago levels. I suspect that one of the challenges for Kimberly-Clark in the future will be in maintaining brand value – local production will certainly help the cost structure, but I do believe the company will eventually have to convince local shoppers that there's a good reason to pay premiums for Huggies and Kleenex.

The Bottom Line
Kimberly-Clark has an excellent dividend history, both in terms of the consistency and the growth of the payout. Likewise, this is a company with strong brands and solid consumer loyalty. What is not as consistent, though, is the history of operating income growth and margins. The company has done a good job of improving its manufacturing process and reducing waste, but input costs like fiber, energy, and packaging are still meaningful.

SEE: 5 Must-Have Metrics For Value Investors

I am looking for Kimberly-Clark to continue growing its free cash flow at a low-to-mid single-digit rate. In fact, I'm looking for the company to post stronger growth over the next decade than it has over the past ten years. Even with that growth, though, the shares do not look cheap. Whether you consider discounted free cash flow, EV/EBITDA, or P/E, Kimberly-Clark shares seem to be sporting a significant premium, and I don't see the growth or earnings consistency here to pay such a high multiple today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Active Trading

    Value Investing

    Learn everything there is to know about value investing.
  2. Active Trading

    Is Warren Buffett Really A Value Investor?

    Warren Buffett has long been hailed as a value investor. But is that statement still accurate?
  3. Active Trading

    The Value Investor's Handbook

    Learn the technique that Buffett, Lynch and other pros used to make their fortunes.
  4. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  5. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  6. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  7. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  8. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  9. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  10. Stock Analysis

    The Biggest Risks of Investing in Netflix Stock

    Examine the current state of Netflix Inc., and learn about three of the major fundamental risks that the company is currently facing.
  1. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  2. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  3. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  4. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  5. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  6. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!