Kimberly-Clark Corp (KMB) — Q2 2020 Earnings Call Transcript

Thank you, and good morning, everyone. Welcome to Kimberly-Clark’s Second Quarter Earnings Conference Call. This morning, you will hear from Mike Hsu, our Chairman and Chief Executive Officer; and Maria Henry, our CFO. We have a presentation of today's materials in the Investors section of our website. As a reminder, we will be making forward-looking statements today. Please see the Risk Factors section of our latest quarterly and annual report for further discussion of forward-looking statements. Lastly, we will also be referring to adjusted results and outlook both exclude certain items described in this morning's news release. That release has further information about these adjustments and reconciliations to comparable GAAP financial measures. Now I'll turn the call over to Maria.

Thanks, Paul, and good morning, everyone. Thanks for joining the call. I hope everyone continues to stay healthy and safe in this environment. Let me go ahead and start with the headlines for the quarter. Organic sales increased 4%, reflecting good underlying momentum and net benefits from increased demand related to COVID-19. We achieved significant cost savings, margin improvements, and record adjusted earnings. Additionally, we achieved all-time record operating cash flow. Now let's cover the details of the results starting with sales. Our second quarter net sales were $4.6 billion, that's up slightly from a year ago and includes a four-point drag from currency rates. Volumes were up 2% and net selling prices and product mix each improved one point. By segment, organic sales rose 14% in consumer tissue and 2% in personal care, but declined 10% in K-C Professional. Mike will provide more color on the top line in just a few minutes. Moving on to profitability, second quarter adjusted gross margin was 39.8%, up 520 basis points year-on-year. Adjusted gross profit increased 16%. We had outstanding cost savings performance in the quarter. Combined savings from our FORCE and restructuring program totaled $175 million, including strong productivity improvements. We are now targeting full year cost savings of $510 million to $560 million. That's up nicely compared to our original range of $425 million to $500 million. Commodities were a benefit of $80 million in the quarter driven by pulp. We now expect full year commodity deflation of $150 million to $250 million, on average that's $75 million better than our original outlook. On the other hand, foreign currencies were a headwind in the quarter, reducing our operating profit by a high single-digit rate. For the full year, currency effects are expected to be a high single-digit drag on operating profit. Versus our original plan, the incremental currency headwinds are about twice the benefit of the improved commodity outlook. Other manufacturing costs were also higher year-on-year. For the full year, these costs are expected to increase more than we originally planned. That's due to incremental expenses related to COVID-19, partially offset by improved fixed cost absorption. Moving further down the P&L, between the lines spending was up 40 basis points as a percent of sales, driven by a nice pickup in digital advertising. All in all, adjusted operating profit was up 28%. Second quarter adjusted operating margin was 21.9%, up 470 basis points versus a year ago. Margins were up in all three business segments with significant improvement in consumer tissue. Consumer tissue margins included an approximate 175 basis point benefit from improved fixed cost absorption. On the bottom line, adjusted earnings per share were a record $2.20, up 32% year-on-year. Let's turn to cash flow and capital efficiency. Cash provided by operations in the second quarter was an all-time record of nearly $1.6 billion, compared to $609 million in the year-ago quarter. The increase was driven by unusually strong working capital benefits, higher earnings, and a temporary delay in tax payments. While cash flow is expected to decline in the back half of the year, we expect full year cash flow will be up very nicely year-on-year. Second quarter dividends and share repurchases totaled about $400 million. That was lower than normal because of our decision to temporarily suspend share repurchases for most of the second quarter. As we mentioned in this morning's news release, we will be restarting our share repurchase program beginning tomorrow. All in all, we delivered very good results across the board, while continuing to invest for future success. I'll now turn the call over to Mike.

Thank you, Maria. Good morning, everyone. I really want to wish you and your families good health and safety. I'll begin by commenting on how we're operating in the current environment and then I'll turn to our results and the outlook. Since the outbreak of COVID-19, Kimberly-Clark has taken decisive action to manage our business effectively through this crisis. Our key operating priorities remain as follows. First and foremost, we are focused on protecting the health and safety of our employees and our consumers; second, we're proactively managing our global supply chain to ensure supply of our essential products; and third, we're prudently managing the business through near-term volatility, while continuing to strengthen the long-term health of Kimberly-Clark. I'm really proud of how our 40,000 employees are managing through the challenges we're facing every day. Our global supply chain organization, led by our frontline manufacturing employees, is doing an outstanding job keeping our supply chain rolling. We have not experienced material impact even as we've had disruptions in several markets with elevated infection rates. Despite the tough environment, our teams continue to deliver strong cost savings and productivity improvements. While much of our attention has been on the near term, we are continuing to execute our longer-term strategies. Our teams pivoted rapidly to pursue new growth opportunities that have been created in the pandemic environment. This includes opportunities to better meet consumer and end-user needs around health, wellness, and protection, both in-home and in the workplace. It also includes opportunities to accelerate e-commerce and digital as consumers change how they engage with our brands. Now, I'd like to make a few comments about our results. As Maria mentioned, organic sales increased 4% in the quarter. In North American consumer products, organic sales were up 12%. Within that, personal care rose 5%, driven by ongoing momentum on premium-tier Huggies, child care, and baby wipes. In North American consumer tissue, organic sales increased 22%. Category demand was strong, reflecting increased at-home consumption and some continued consumer stock-up in bath tissue. Category growth moderated in the latter part of the quarter. Shipments exceeded category demand, especially in bath tissue, as we worked 24/7 to restore customer inventory levels. Turning to K-C Professional in North America, organic sales declined 3%, and volumes fell 9%. This decline reflects the challenging environment. I’ll note that we experienced strong shipments early in the quarter, which included benefits from higher-than-normal customer orders in late March that were ultimately fulfilled in April. Now, by product category, second quarter volumes were down about 20% in washroom, down double digits in safety, and volume was up double digits in wipers and other products. Moving to developing and emerging markets, sales were down 3%, driven primarily by K-C Professional. Personal care organic sales in developing and emerging markets were up 2%. In key personal care markets, organic sales were up mid-teens in China and up double digits in India. In Eastern Europe, organic sales were up slightly, although results were impacted by some destocking and the impact of economic lockdowns. In Latin America, organic sales fell low single digits despite favorable pricing in Argentina. Category demand in many developing and emerging countries has been impacted by a drop in consumer purchasing power and government restrictions on social mobility and store operations. In developed markets, organic sales were up 3%, driven by strong growth in consumer tissue. We are also very focused on improving our market positions and making good progress overall. We're growing or maintaining market share in approximately 60% of our 80 category/country combinations that we track. In North American consumer products, market shares are up or even in five of eight product categories. In developing and emerging markets, shares were up in Eastern Europe, up or even in China and somewhat mixed in Latin America. In developed markets, shares were up in South Korea and the U.K. To summarize our first half, I'm very encouraged by our progress. We're delivering strong financial results, strengthening our market positions, and managing through this crisis safely and effectively. Now I'll address the outlook. The duration and impact of COVID-19 on our business remains unclear, and there continues to be uncertainty in the environment. However, our visibility is improving, and we're restoring forward-looking guidance for 2020. Compared to our original plan, we're raising our outlook for both organic sales and earnings. We're also increasing growth investment, primarily in digital advertising. On the top line, we're targeting organic sales growth of 4% to 5% which is above our original plan of 2%. This increase reflects a combination of improved underlying brand performance and higher demand driven by COVID. In addition, we expect bath tissue sales in North America will benefit from more people being at home and from our actions to improve customer inventory levels. On the bottom line, our revised outlook is adjusted earnings per share of $7.40 to $7.60, that's up 7% to 10% year-on-year compared to our original plan of $7.10 to $7.35. While we're increasing our outlook, we'll also invest more in our brands and capabilities. In conclusion, we remain very optimistic about our opportunities to generate long-term growth and create shareholder value. We'll continue to prioritize the health and safety of our people and our consumers. We're executing our strategies well and we continue to operate our business with a balanced and sustainable approach.

Hey Dara. Dara, you may be on mute.

Can you guys hear me?

We got you.

Yes, we got you.

Okay. Great. Hope all is well on your end. Your full year EPS guidance even at the high end seems high single-digit year-over-year earnings dropped in the back half of the year. So I was just hoping for a bit more clarity on some of the drivers behind that? First, I'm assuming a consumer pantry deload probably depresses top line results a bit given your comments about moderating category growth towards the end of the quarter, but perhaps that might be offset by you guys rebuilding retailer inventory levels from a shipment perspective. So just any commentary on sort of the hangover from a topline standpoint in the back half versus the first half elevated levels would be helpful? And then second, you mentioned the reinvestment back behind advertising. Can you give us a sense? Is that a significant amount of reinvestment versus your original guidance a couple of quarters back, as some of the other P&L line items have come in better than expected? And then just last have you budgeted more conservatism into that guidance than you normally would for the back half, just given the volatility in the environment? Thanks.

Okay. Thanks, Dara. A handful of questions. Let me lead off, and I'll ask Maria to jump in because I think she'll give you a little bit better context. But I will say, resuming the guidance definitely reflects our growing confidence in our ability to safely operate in this COVID environment. There are some big puts and takes certainly in demand. We see a net favorable impact on demand overall though. That reflects the strong demand growth in North America obviously in tissue, which happens to be one of our largest businesses. We are seeing some offsetting effects both in KCP and as I mentioned, some D&E markets outside of China. I think that still remains to be seen. At this point of year, I think our range is still fairly wide, and that probably reflects, to some degree, some of the uncertainty that still exists out there. But overall, we feel like demand should be for us a net positive. On the investment side, definitely in the second half, our plan was tilted to increase investment in the second half or a little bit more investment in the second half. We feel very good about where our product quality is and where our marketing and communications programs are for consumers, and we feel very confident about the underlying brand performance globally in most markets. And so, we really feel good about increasing our investment. The plan is for us—we had a pretty significant uptick last year. I think it was about 60 basis points in advertising increase, and our plan this year would be north of that. That was our original plan, and we plan to meet that. But Maria, do you want to jump in there?

Sure. I think, Mike, you covered the highlights. When I think about the year, the overall financials look really good. As we raised our OP growth forecast, we've raised our EPS forecast for the year. Operating cash flow should be stronger for the year than we expected back in January. So overall, financially, this should be a really good year for Kimberly-Clark, and all of that with increased investment in our business not only for the near term but the long-term. The way that favorability comes in is that it's first half weighted, for obvious reasons given the COVID situation and its flow-through impacts on our business. When I look at the full year outlook, we're benefiting from solid top line growth, which is led by volume growth plus benefits from mix and price. Currency headwinds are expected to be partially, but not entirely offset by commodity deflation benefits. Savings are strong. We've raised our outlook on total savings from FORCE and GRP to $510 million to $560 million for the year. As Mike said, we are significantly increasing investments this year, particularly in advertising, but also in other areas like long-term capability builds. So for the total year, it looks good. If I compare the first half to second half and give you a little bit more detail, in the second half, for profit, we will have a—we're expecting slowing volume growth, which impacts our profit where we had a sizable benefit in the first half. A little further benefit from 2019 pricing actions, and also as shelf availability improves in the back half we should see a return to more normal levels of promotion. Commodities are becoming slightly—modestly inflationary by the end of the year. Also, our cost savings are not expected to be as strong in the second half, and we're also increasing our investment in the back half of the year, as Mike talked about. That's really what's going on. My comment on the guidance is, I'm happy to reinstate guidance at this point, given that we have more comfort in our supply chain team's ability to maintain our operations during spikes of COVID. The supply chain risk has been reduced, number one. Number two, the commodity currency environment overall has calmed down since where we were in March and April. So I would say the guidance is realistic and reflects what we're thinking based on what we see and the actions we intend to take through the remainder of the year.

Okay. That's very comprehensive. That's helpful. And then on the promotional environment, you mentioned in the pricing environment, obviously, we've seen a big promotional pullback in the U.S. here post-COVID. What are you guys expecting in the balance of the year? Does some of that linger? Do we get more back to a normalized type of environment? Particularly, if category growth weakens a bit, does that create more risk? And perhaps just touch on what you're seeing from a competitive standpoint, particularly on the private label front here in terms of the U.S. pricing environment.

Yes. U.S. in particular, I think, Dara, I would say, the same thing I said last quarter is that I think the market has broadly been constructive. That's because right now, especially the focus is on supply, and we still are rebuilding inventories. I'd say, we've made progress on the personal care side, and we're still catching up and gaining on tissue. But our service levels still aren't where we want them to be, and our in-stock still isn't where we want it to be. We're not promoting as much as we had in the past in this environment. I think actually the categories or other players in the market are not promoting as much either. A couple of factoids: Volumes sold on promotion in the quarter for the category were down depending on the category somewhere between 25% and 50%. That does reflect the situation and makes sense for the business at this point.

Okay. And I was getting more sort of the back half of the year, what you guys are expecting, what you started to see towards the end of the quarter so far in July? Have you seen any changes in behavior? And is this sort of new environment post-COVID likely to linger in your mind, or could you see a ramp-up with category growth dissipating a bit? So, looking more ahead as we look out to the balance of the year. Thanks.

Yes. I don’t see it changing significantly in the balance of the year because of the supply situation. I mean, I think I just said that we're making a little progress in improving our supply situation on tissue, but we still have a lot of work to do to catch up, and because of that supply is still tight. I don't see certainly from our end a heavy promotional environment from our perspective.

Hi. Good morning everyone. And congrats on the strong results in the first half of the year, particularly given the environment. Mike, just to pick up on some of the line of questioning regarding investment levels, particularly around advertising and marketing. What do you think is the appropriate level longer term? Will the step-up that you're targeting this year be a permanent one? And maybe help us think about the magnitude of the increase this year because when we kind of tumble through the numbers and then for you as well, Maria, just given what you've provided with respect to commodities and for savings and restructuring and FX, there's a pretty substantial offset to get to your numbers. So how much of that is advertising and marketing? And how should we be thinking about that? And Mike, how are you thinking about it longer term?

Yes, I'll let maybe Maria comment further on kind of the details of the step-up. We are planning a significant increase this year just as we did last year. Kevin, we have not set internally a long-range target, but I would recognize while historically, our advertising has been about average for the industry, it's been less than some of our direct competitors. So we feel like there are two factors that we want to do, which is to accelerate growth—and we feel like we need to fuel that with better products and better programming, both advertising and sales programs to drive our business and market development programs. At the same time, it's going to require more investment, and we're doing that. Now, we don't have a long-range target that's public but I would say we would like to be north of where we are today and what we finish this year.

Yes, I would just add that as a reminder our advertising investment will be back-half loaded, and our capability building investments will also be back-half loaded. You may recall that when we were on the phone in April, we talked about the fact that with all of the volatility and uncertainty we were pausing some of our investments. The back-half higher numbers are partially related to that stepping back up to our original levels of investment and then also increasing the level of those investments given the overall performance for the year.

I think we are looking at the second quarter gross margin in comparison to the previous year, but more importantly, relative to the first quarter due to various factors. Based on the main disclosures, it's difficult to understand how the margin improved by 260 basis points in Q2 compared to Q1. Could you explain that a bit more to help us understand the different elements involved?

Sure. A few pieces to comment on. The savings in the second quarter were very strong as we discussed. On the margin side of the house, we also have benefit from geographic mix. So, when you look across the board the stronger performance in North America, where our margins are higher than in developing and emerging markets, definitely helped us on the margin side of the house. So, those were two of the bigger drivers.

Okay, okay. That makes sense. I guess the other question and I think you talked a little bit about this. But I guess as I listen to your answers to Kevin's question to Lauren before that, is there maybe you can just talk a little bit more to the extent you can on the specific nature of the second half investments. Just a little bit more specificity would be helpful. And I guess I'm really trying to get a sense for how much of those investments are more tactical where we can think of the returns that you mentioned sort of being yielded in the next 12 months versus those that are longer term in nature that are capabilities that won't yield a return necessarily next year but in the coming two or three-plus years. Is there a way to describe that balance?

Yes, yes. I think let's see, Steve. I guess I would probably characterize them all as longer term in nature. But that includes advertising and brand building and capability investment. Both I classify as more long-term in nature versus what I would say short term, 'Hey we're going to do a big buy one get one free promotion.' So it's less tactical in that sense and more long-term in the sense of building equity over the long term. The caveat is that most of the advertising investment is in digital, and that does generate returns sooner. That has both an equity-building component and in some ways a volume-driving component. A big chunk is, as Maria mentioned in her remarks, digital advertising. We are investing a significant sum that will flow through to more of the overhead lines in capability building. We're making significant investments in revenue growth management, which is going to help us with trade promotion efficiency and our price pack architectures and how we do pricing globally.

Yes. That's helpful. I guess just last follow-up on that is just the lead time you need to make on these investments. Are these investments that, as we sit here in July, you've kind of earmarked and locked in for the back half, or especially there’s not a lot of flex in it, or are there elements to the investments that can be flexed to the extent that the pricing environment that right now looks good kind of looks differently or the demand environment dries up? Just how much discretion and flex do you have in what's lined up for the second half?

Well, maybe I'll let—I'll defer to Maria's judgment here, but I would say there's always some flexibility. Nothing's ever set in stone unless we've bought upfront everything, which in our case we haven't. By definition, I think there's a lot more flexibility in digital in terms of how we go to market there. So Maria, any additional insights?

Yes, I think that's right. We do have some flexibility on the discretionary investments that we plan to make in the second half of the year.

Yes. So, Mike, I just wanted to kind of get your sense. Obviously, things are changing at a rapid rate in terms of openings and closings, and that has an impact on consumption, especially at-at-home consumption. So I was just hoping you can give us some context on what you're seeing in July as it relates to some of the changes that have been taking place on a regional basis? And is your supply chain in a position yet, where it can actually execute based on some of these very micro regional changes whether it be by county or by just that city or state level?

Yes. Nik, I assume you're really asking as infection rates change around markets or locations? Well, I'll talk maybe operations and then the economy. One, I'll start with our operations, which I think the team has been doing a phenomenal job executing very well with a really disciplined approach to COVID-19. We really have been prioritizing the safety of our employees in our plants. We've had some sporadic outages. I will tell you, we're on the mode now is we're tracking the infection rates very closely to the lowest level possible. In the U.S. that means by county is where we make our decisions. We proactively close plants for cleaning or make other decisions based on what those infection rates are. Overall, as I mentioned earlier, I think we've become more confident in our ability to operate in an infection rate environment that fluctuates, and we've done that throughout this year thus far. From an economy perspective, again, we're still kind of working through the changes. I think we highlighted in Q1 that there were some question marks in developing and emerging markets around how that would be affected. That has been realized particularly in Latin America, where we're seeing a fairly high impact of COVID plus in a lot of the markets down there very strict government lockdowns on social mobility. As I mentioned earlier, less money for consumers to spend, and we're seeing a bigger impact. We've made the call in our forecast, and we feel like we have it called right. But it is one of the reasons why we left the range a little bit wider because some uncertainty still exists. But net-net, I would say, if you look at the U.S., we expect and we mentioned in bath tissue probably will be modestly higher because of people being at home more often. With the U.S. being our by far our largest market, that's a net positive financially, and we’ll work through some of the challenges in some of the D&E markets even though our underlying brand performance continues to be strong.

Hi. Good morning. And congrats for restoring the guidance and buybacks and also the Brothers team for shipping all this volume. So, can you comment on what you saw in orders exiting the quarter for both developed and emerging markets on the consumer side? And in the professional business, in other words, what was the volume rate in June much lower than the quarter, or you were still catching up on the stock and destocking as you said a couple of times in this call? And following up on the mix comments in emerging markets, it's great to hear about the margin accretive innovation in Brazil, but are you seeing category improving also in China and Eastern Europe, or disposable income pressures are more than offsetting the reopenings? Thank you.

Yes. Maybe I'll start with—I think the KCP, just to give you a little more texture. I think definitely the business is impacted by the global slowdown, but the team is really pivoting aggressively to create healthier workplaces. The organic overall for the business globally was down 10%. North America was down 3%. As I mentioned, we had significant orders in March that we shipped in April. That offsets. So I think the run rate is a little worse than 3%. But there's a couple of factors. Definitely declines in the core washroom business, I mentioned globally, but I think the washroom business was down about 20%. Offices, industrial travel and lodging all significantly down and remain significantly down. We do see some pickup in health care, grocery, and e-commerce that's offsetting that to some degree. In K-C Professional, we are capturing growth. As I mentioned, wipers are up double-digits and so that's a positive one for us with a positive mix effect. We are expanding our mask offering. We had sold some co-pack masks so we have a very small mask business, but we have begun self-manufacturing masks. We feel like we have great technology from a materials perspective. We're a large non-wovens producer. We feel like our non-wovens fabrics are excellent materials for masks. We started for internal production for our mills using our plants, but we are selling them externally now, and that will be a good part of our business going forward. So that's the KCP part. I think your question on the consumer side. Again in personal care, there was a pronounced stock-up in the first quarter, and we have double-digit growth across the categories. If you think about personal care like a diaper, there's no reason for a surge like that. Subsequently, in Q2 we're seeing—if you look at the Nielsen, some of that reverse out. We do think in personal care overall it'll level out to more normalized numbers still probably positive, but more normalized. In tissue, people at home equals more use at home. We'll see, I think, a fairly significant growth this year overall for the tissue categories. We're up in all three tissue categories in North America and think despite there's been a little softness in the last quarter with some reversals, we still should see a higher overall consumption in tissue both in North America and other developed markets for the balance of the year. So I'll pause there. I think there were a couple of other questions there. If you could just remind me, Andrea, what else you want me to hit on.

Yes. Sorry, Mike. Yes. I wanted to just go—if you take us throughout the world. But before you do, like just to finalize your comment about the consumer tissue business. Are you seeing—because what we've seen, Nielsen obviously, doesn't capture the non-track channels. Are you seeing—are you losing share or like industry? I mean, I think you mentioned like five out of eight categories that you're gaining share. So that I'm assuming is encompassing of all channels. So if you can take us through that and then talk about take us throughout the world also for China and Korea in terms of share of those categories?

Yes. Okay. Yes. So largely, I think we feel very good about our share performance, and we're making progress there. By the categories, we track, and we track 80 country-category combinations, what we call in the cohorts. We're up or even in 60% of those. In North American consumer products, market shares are up or even in five of eight product categories. In developing and emerging markets, shares were up in Eastern Europe, up or even in China and somewhat mixed in Latin America. In developed markets, shares were up in South Korea and the U.K. To summarize, I think we're making good progress overall. We're growing or maintaining market share in approximately 60% of our 80 category/country combinations that we track. In North American consumer products, market shares are up or even in five of eight product categories. In developing and emerging markets, shares were up in Eastern Europe up or even in China and somewhat mixed in Latin America. In developed markets, shares were up in South Korea and the U.K.

Hi. I know this has been a long call, so I want to make my questions really direct and short. And then simply on the professional business, that business we all expected I think to be weak. I'm wondering number one, what are you seeing in the third quarter has just started. But what are your expectations for trends in that business in the third quarter, same type of volume decline better or worse? And can you remind us of the gross margin in that business? Is it above or below corporate average? Thanks.

Yeah. Maybe I'll have the trend. And maybe Paul or Maria if you could, the gross margin, I don't have that off the top of my head. But I think the trend, I would say, and given the remarks we made, Wendy, would be probably slightly worse than what we had in the second quarter, because of the high orders that came at the end of March that were shipped in April. So the run rate is probably a little worse than 3%. That said, we’ll have the core washroom business down double digits. We are making progress on our wipers. And as I mentioned, our new mask business. Those will be offsets to the good.

And Paul, I'm not sure about—if we comment on gross margins. So I'm going to pass that to you.

Yeah. Thanks, Maria. So we don't provide specific numbers at the segment level on gross margins. What I would say is that, maybe not surprisingly, margins for KCP would be in between personal care and consumer tissue. And they're pretty healthy overall.

I think that one the team is doing an outstanding job managing the costs. But also they're doing an outstanding job pivoting to maybe what I think our—Russ our president of that division would call kind of the essential to create healthier workplaces, right? It's now mission-critical to create a healthier workplace. The notion that wipers and masks will become a bigger piece of the business, it has a positive mix effect from a margin perspective.