Fitch Rates Kimberly-Clark's New $500MM Notes 'A'; Outlook Stable
The notes will be issued under a global indenture dated March 1, 1988 as further supplemented. The indenture contains limitations on liens and sale/leaseback transactions; however, there are no financial covenants in the indenture. Similar to notes issued after 2006 there is a Change of Control Triggering Event. The trigger is upon the occurrence of both a Change of Control (any person becomes the beneficial owner of 50% or more of shares or a substantial disposition of property, for example) and a rating downgrade to below investment grade from each of the three rating agencies. In this event, unless the company has exercised its right to redeem the notes, Kimberly-Clark will be required to make an offer to purchase the notes at a price equal to 101% of the aggregate principal amount plus accrued and unpaid interest to the date of repurchase.
Net revenue declines at the upper end of the company's public guidance of 3% to 6% which includes KMB being able to obtain additional pricing to cover depreciating currencies as an offset to the anticipated 8% to 9% currency translation drag. However, price increases are likely to result in at least short term volume declines as growth slows in several economies such as Russia. The Procter & Gamble Company, the largest firm in the sector, experienced a slight decline in developing market volume as it priced to offset foreign exchange devaluation across several countries. Even in developed markets consumers have generally responded to price increases with volume declines as pantries are drawn down. Attaining KMB's public guidance for a 2%-3% increase in volumes is likely to be pressured.
EBITDA margins tick modestly below last year's 20.8% with less sales than expected over fixed costs. Based on Fitch's expectations for crude at \$50/bbl in 2015 and \$60/bbl in 2016, if currencies stabilize around current levels there is likely to be larger deflation that could further firm margins. However, Fitch has not factored the scenario into projections in order to be conservative.
KMB has very strong financial flexibility and will continue to manage to have strong credit protection measures within the current rating category.
KEY RATING DRIVERS
Scale, Leadership in Stable Sector:
KMB's scale, with over \$19 billion in revenues, leading market shares in tissue-based personal care products, as well as strong liquidity, are key underpinnings to the rating. The firm is a global hygiene company with approximately 50% of net sales and 65% of operating profit (before Corporate & Other expenses) generated in North America. Its principal products such as Huggies diapers, Depends for adult incontinence and Andrex toilet paper occupy leading positions in most markets. Euromonitor International cited that the company's diaper/pant was the second leading brand in the U.S. with a 39% share in 2013.
Commitment to Rating Profile:
KMB's management is mindful of the company's corporate ratings and publicly states its commitment to operating within the 'A' category. Historically, discretionary activities such as share repurchases have been scaled back when cash flows experience pressure or if fill-in acquisitions are required. The last instance was in 2009 when the company suspended share repurchases and increased the contribution to its pension plan by \$716 million partially close the large funding gap that developed after the financial crisis of 2008.
Modest Leverage Cushion:
The company's leverage increased moderately to 1.7x from 1.5x as anticipated without Halyard's cash flows post spin-off. If margins or operating cash flow are weaker than expected, Fitch expects the company to scale back some of its discretionary activities or reduce debt to maintain leverage at or below 2x. KMB operates with leverage below 2x and should continue in this fashion. As long as the company maintains its current business momentum which includes solid levels of brand support and innovation, the company could add nearly \$500 million in pro forma debt (excluding this pension related transaction) at Dec. 31, 2014 with minimal rating implications.
Intermittent Input Cost Pressures:
Commodities used in the manufacturing process, such as resin, pulp, and energy, experience periods of price volatility that can pressure margins. The near term commodity outlook is benign and likely to be modestly deflationary given the rapid decline in oil prices. However, longer term, oil and other input costs will generally remain volatile and may resume their general upward momentum. KMB has addressed increased costs through ongoing and intermittent restructuring programs, pricing in some markets, and exiting low margin regions and product lines. The company has a long and successful track record of containing costs and has had solid organic growth rates in the 3% to 5% range. As a result, there have been sequential improvements in EBITDA margins to 20.8% in 2014 from 18.9% in 2011. A focus on costs and organic growth should moderate or limit the negative impact of future input cost spikes.
Sizeable Liquidity, Financial Flexibility:
At Dec. 31, 2014, Kimberly-Clark had very comfortable liquidity of \$2.8 billion with almost \$800 million in cash on hand and a \$2 billion unutilized revolver maturing in June 2019. Most of the company's cash is normally held in international markets and may not all be available to reduce debt balances. Long-term debt maturities in the next two years are moderate at less than \$600 million and are likely to be refinanced in order to maintain the current capital structure and leverage in the 1.5x to 2x range. In 2015, the \$200 million dealer remarketable security, the \$300 million 4.875% notes, and a \$37 million IRB mature.
The company's strong financial flexibility stems from its ability to consistently generate approximately \$3 billion in operating cash flow annually. Operating cash flow is likely to fall below the three year average of \$3 billion to \$2.5 billion to \$3 billion in 2015 with pressure on margins and profits from a strong U.S. dollar but should revert to historical levels in 2016 and thereafter. Dividends and capex have a \$2.3 billion run-rate and are the basics needed to re-invest in the company and meet shareholder expectations. Fitch notes that KMB has generated at least \$2.3 billion in operating cash flow since 2002. Funds from operations (FFO) interest coverage has likewise been healthy in the 10x range.
Future developments that may, individually or collectively, lead to an upgrade include:
The company has the flexibility to manage its credit metrics at stronger levels given stable cash flows. Committing to operating with leverage below 1.5x would support upward migration. However, the company appears comfortable with its current ratings and thus an upgrade does not appear likely.
Future developments that may potentially lead to a negative rating action include:
A change in financial strategy to operate with leverage above 2x, most likely through a large debt financed share repurchase program or a transformative acquisition, would be a negative driver. Such an event would be assessed upon its occurrence. Further, any impairment in the company's ability to consistently generate operating cash flow in the \$2.5 billion to \$3 billion range would be of concern. These situations arise due to meaningful market share losses or prolonged and significant increases in major commodities concurrent with an inability to fully pass on price increases.