Portfolio Strategy

October 4, 2019

The Long and Short

Attractive extension swap in Kimberly-Clark

Meredith Contente | October 4, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Kimberly-Clark Corporation (KMB) has posted much stronger operating performance in 1H19, making the idea of an extension swap more attractive. Currently swapping out of KMB 3.05% 8/15/25 into KMB 2.75% 2/15/26 allows a pick-up of 12 bp in g-spread, or 2 bp per month, while taking out over 2 points in dollar price. The swap also results in a slight increase in liquidity as investors move into a larger deal size of $400 million versus $300 million.  Lastly, the KMB 2.75% 2/15/26 bonds are trading on top of the on-the-run 10-year bonds, the KMB 3.2% 4/25/29, on a g-spread basis.

Exhibit 1: KMB intermediate curve

Source: Bloomberg

Much improved operating performance  

After a soft 2H18 which saw roughly 70 bp of EBITDA margin deterioration, KMB’s refocused efforts on cost savings and operating improvements has led to solid 1H19 results.  1H19 EBITDA margin was up a solid 220 bp from the year ago period, largely driven by its continued FORCE (Focused On Reducing Costs Everywhere) program, restructuring savings and price initiatives that more than offset commodity and currency headwinds. The company established the FORCE program back in 2018 to target $1.5 billion in cost saving through 2021. KMB posted 5% organic sales growth in 2Q19 and 4% for 1H19, its strongest quarterly and half year organic sales performance in over 3.5 years. Sales growth was driven by both improved pricing and better than expected volume growth, particularly in North America.  Management noted that selling prices in North America during the quarter were up 4% year-over-year, with volumes up slightly.

Exhibit 2: KMB quarterly sales/margin performance

Source: KMB company reports, Bloomberg, Amherst Pierpont Securities

Full year guidance raised

Given the better than expected 1H19 performance, management raised both top and bottom line guidance for the full year. Net sales are now expected to be flat to down 1%, versus previous guidance of down 1%-2%, while organic sales growth for the year was increased to 3% from 2%. Adjusted operating profit growth will now be in the 3%-5% range, up from the 1%-4% originally expected. The driving force behind the increased profit guidance is an improved inflation outlook, particularly for pulp and to a lesser extent for other raw materials including superabsorbent and polymer resin. That said, inflation in key cost inputs is now expected to be in the $150-$250 million range, down from $300-$400 million. Higher marketing spend is expected to slightly offset the improved inflation outlook. Adjusted EPS was raised to the $6.65-$6.80 range, up from $6.50-$6.70.

Leverage comfortable for current ratings

Estimates are that KMB ended the quarter with adjusted leverage of 2.1x, which is comfortable for its A2/A ratings.  This is down from roughly 2.4x at year-end 2018. Both the FORCE program and the restructuring initiatives should further improve EBITDA margins, thereby reducing leverage. Leverage should decline to 2.0x or slightly below by year-end 2020 based on EBITDA estimates. Management does not need to reduce debt, therefore capital allocation policies are expected to continue to prioritize shareholders via dividends and share repurchases. As such, management reiterated that it intends to return $2.0-to-$2.3 billion to shareholders this year. KMB has no debt maturing in 2019 and $750 million maturing in 2020, which they will likely look to refinance.

Meredith Contente
1 (646) 776-7753
mcontente@apsec.com

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