As an investor, you want the odds on your side.
When investing in a company you’re basically making a bet that the company will make more money and be more successful over the long haul.
As a dividend growth investor, I make a side bet that the company will also pay out more of their rising cash flow via increasing dividends.
So you want the odds on your side when you’re making these kinds of long-term bets.
[ad#Google Adsense 336×280-IA]And when trying to maximize my odds, I like to invest in companies where it’s easy to see how and why they’re going to make more money for many years to come.
For instance, I generally avoid investing in tech companies.
And that’s because I don’t know what’s going to happen with smartphones or computer chips over the next 20 years.
Technology changes extremely fast.
But you know what doesn’t change very fast?
Diapers, facial tissue, paper towel, and bathroom tissue.
These products haven’t changed much in 20 years, and the odds are pretty good that they won’t change very much over the next 20 years either.
And that’s why a company like Kimberly-Clark Corp. (KMB) has done pretty well for itself selling these types of products.
It was founded way back in 1872, and you don’t build the kind of staying power necessary to still be relevant and profitable almost 150 years later if you’re not providing products that people demand.
Kimberly-Clark Corp. (KMB) is a consumer products company that manufactures and markets products mostly made from natural or synthetic fibers.
They operate in four segments: Personal Care (45% of fiscal year 2013 sales); Consumer Tissue (31%); K-C Professional & Other (16%); and Health Care (8%). However, the company has announced that it plans to spin off its health care business into an independent publicly traded company, and is expected to close that transaction in 2015.
North America accounted for 49% of the company’s 2013 sales.
This company is just a monster. They have a number of leading brands, including: Huggies, Kleenex, Scott, Kotex, Pull-Ups, and Depend. These brands are sold in more than 175 countries, and nearly one quarter of the world’s population purchase their products every single day. The company holds a #1 or #2 brand share in more than 80 countries.
The great thing about their products is that they must be replaced once used. You obviously can’t keep reusing personal tissue or diapers. So this creates a great recurring source of revenue for the company.
And speaking of recurring revenue, let’s see what kind of revenue and profit the company’s been able to post over the last 10 years. Their fiscal year ends December 31.
Revenue increased from $15.083 billion in FY 2004 to $21.152 billion in FY 2013. That’s a compound annual growth rate of 3.83%. Not as high a growth rate as one might like to see, but not too shabby either.
Meanwhile, earnings per share grew from $3.55 to $5.53 over this time frame, which is a CAGR of 5.05%. Again, not overly impressive, but not bad. But it’s possible this growth rate will increase for the foreseeable future, as S&P Capital IQ predicts EPS to grow at a compound annual rate of 8% over the next three years. They cite price increases and cost savings from past restructuring as some of the driving forces behind that prediction.
These are pretty decent numbers, but a major metric I like to look at is how a company is rewarding shareholders via dividend payouts and raises. And Kimberly-Clark doesn’t disappoint here.
They are featured on David Fish’s Dividend Champions, Contenders, and Challengers document, which lists and tracks 553 stocks that have increased their dividends for at least the last five consecutive years. Actually, they’re more than just featured. They’re a “Champion” because they’ve increased their dividend for the last 42 consecutive years.
I’ve said it before, and I’ll say it again. You can’t pay shareholders increasing cash dividends for decades upon decades if you’re not doing something right. Those dividends are paid in the form of cash, and have to come from cash. Therefore, a business must generate more and more cash from selling more products and/or services in order to fund more payouts. Poor businesses generally don’t build such reputations and track records.
And while over four decades of dividend growth is impressive in its own right, investors also want to make sure their purchasing power is at least staying intact over time; increasing purchasing power, however, is even better.
After all, if the dividend isn’t increasing, then it’s impossible to keep up with inflation and rising prices.
KMB has increased its dividend by an annual rate of 9.2% over the last decade. That’s very solid growth, and that’s obviously higher than how fast earnings have grown. And this has led to a payout ratio of 60.3%, which is moderately high. So dividend growth will likely have to slow to a rate more in line with earnings going forward.
But the current yield on shares, at 3.14%, is well above what the broader market’s average. So this stock is kind of in a “sweet spot” if you will, where you have moderately high yield with fairly substantial dividend growth. Generally speaking, a good proxy for total return is the sum of the yield and dividend growth rate, assuming a static valuation. So a yield of 3%+ and dividend growth of 7%+ usually leads to pretty solid double-digit total returns, if the valuation remains unchanged.
The company’s balance sheet is leveraged, but stable. The long-term debt/equity ratio stood at 1.12 by the end of 2013, while the interest coverage ratio is 11.4. So they have some debt, but it’s not at an uncomfortable level, as they can easily cover interest expenses.
And you might wonder how profitable it is to sell paper products and diapers? Well, pretty profitable. Net margin has averaged 9.14% over the last five years, while return on equity has averaged 35.65% over the same time frame.
Kimberly-Clark might be thought of as a pretty mature company, and with a market cap of almost $40 billion, you might be right there. But that’s a great thing for a defensive investor looking to receive increasing dividend checks for the next couple of decades and beyond. They’re established in key markets around the world selling a product that people need and that must be replaced once used. You might not experience huge growth with an investment in KMB, but if you’re after stable, rising income, this is a good play here.
And the dividends aren’t the only thing driving shareholder value. As aforementioned, they’re spinning off their health care brand in 2015, which could drive additional value all by itself. In addition, they’re buying back gobs of shares – over 100 million over the last 10 years – which drives earnings growth and increases ownership in the company among remaining shareholders.
Again, it’s all about playing the odds. Would you rather make a bet on technology or diapers? I like businesses that are easy to understand, sell products and/or services that are ubiquitous, are well-run, and reward shareholders handsomely. Kimberly-Clark checks all these boxes.
However, there are risks to an investment in KMB. Primarily, you have a very competitive marketplace. Diapers and paper products are obviously profitable, so there are other companies that have entrenched brands and market share that compete fiercely.
Shares in KMB are valued at a price-to-earnings ratio of 19.21 right now, which is just above where the broader market is. Moreover, that’s above its own five-year average P/E ratio of 16.9. So shares might be a tad rich right now looking quickly at this ratio.
I independently valued shares using a dividend discount model analysis with a 10% discount rate and a 6.5% long-term growth rate. That growth rate is lower than what the company has managed to increase dividends at over the last decade, but the high payout ratio means they’ll have to grow their dividend in line with earnings. And earnings have not grown that quickly over the last decade.
This rate is roughly between the 10-year average EPS growth rate and the predicted growth rate moving forward. That gives me a fair price of $102.24, which is slightly below where shares are trading at right now. One would probably do well to wait for slightly cheaper prices before entering a position.
Bottom line: Kimberly-Clark Co. (KMB) is a global juggernaut selling products like paper towel, bathroom tissue, and diapers. People all over the world need these products on an everyday basis, and the fact that they can’t easily be reused means there is a constant source of recurring revenue in place. The odds are quite good that their 42-year streak of increasing the dividend continues for decades to come, which should enrich shareholders for many, many years.
–Jason Fieber, Dividend Mantra
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