Equity Valuation Project
Part A
1. Through the first two quarters of 2020, the United States has experienced a severe decrease in real GDP with a subsequent bounce back in the third quarter. In the first quarter, the real GDP only fell 5% as the beginning of travel and quarantine restrictions came in March. In the second quarter, real GDP fell 31.4% as the harsh economic reality of the shutdowns hurt all sectors of the economy. However, as the country and, most of the world, began to open real GDP rose 33.1%. Despite the strong third quarter performance, real GDP is still down for the year. Looking at which components of GDP directly affect KMB, it shows the more drastic effect it experienced relative to the rest of the economy. During the first quarter of the year, clothing and footwear sales were down 34.6%. In the second quarter, it experienced a 48.7% decrease in growth. On the upside, the third quarter provided 161.3% growth for the sector helping recover most of the loss from earlier in the year. Additionally, KMB is a global company with sales in 175 countries and have been exposed to the sharp decline in trading over the past two quarters. Exports fell 9.5% and 64.4% in the first two quarters respectively. Imports fell 15% and 54.1% in the same time period. In the third quarter, exports and imports bounced back on improving trade conditions with 59.7% and 91.1% growth respectively.
KMB operates mainly in the Personal Care industry. Sales has not seen a drop off with sales growth in the first three quarters reporting at 3.2%, 3.3%, and 0.3%. Relative to the S&P500, Personal Care has performed better YTD, 13.57% to 11.49%. When looking at annual performance over the past 15 years, Personal Care tends to slightly outperform the US economy, especially in times of economic recession. During the Great Recession, the industry went on a ten-year run of outperforming the US economy from October 2007 to September 2017. Since 2017, performance has been mixed as Personal Care fell behind until late 2019. Once again, Personal Care is slightly performing better than the US economy over the past year. It is worth noting in the long term, both have the same return, 287.16%.
2. Household and Personal Care is a maturing industry. When looking at the key players in the industry, many of the largest companies, by sales and market value, are well-established, blue chip companies such as Proctor & Gamble, Clorox, Colgate, Energizer, etc. Additionally, looking at the Beta for the industry, over the past year it is 0.8, shows that there is less volatility relative to the rest of the market. Moreover, looking at sales growth over the past decade there is not a consistent level of growth observed. From XXXXXXXXXX, the industry saw high growth and then slow growth which were not shifting in one way or another. Then from XXXXXXXXXX, the industry experienced losses in sales which were large, especially relative to the rest of the economy’s performance during the same period. Since 2016, the industry has experienced similar growth patterns as seen at the beginning of the decade but has been trending down due to quarantine restrictions effecting the entire economy. Another datapoint worth nothing is the trend in price-to-earnings ratio over the past decade. It has nearly doubled from 2010 to 2020 which suggests investors are willing to pay more for earnings for these companies.
3. Threat of New Entrants: Low
As previously mentioned, this industry is mature. This means that there is a high cost of entry for new companies. Companies in the industry are well-established which means they have large economies of scale and high
and loyalty which would result in high economic and accounting costs for any prospective entrants.
Bargaining Power of Buyers: High
Buyers in the personal care industry do have a lot power relative to the companies. Price sensitivity is strong with customers willing to buy cheaper goods if their income shrinks. Additionally, switching costs are low if non-existent as most of these goods are found online or in
ick-and-mortar stores. Substitution costs are also very low as most of these goods are non-durable. Moreover, the differentiation in the industry is relatively low as most products are not unique and closer to commodities.
Threat of Substitute Products: High
As mentioned in bargaining power, switching costs are low for customers. Additionally, looking at the ability to substitute, it is easy for customers to change between companies. There are similar prices between substitutes, a high number of substitutes, and buyers do respond to price sensitivity. All these factors indicate that product differentiation is relatively low and substitute goods have power over companies within the industry.
Bargaining Power of Suppliers: Medium
Suppliers have some power relative to the companies in the industry. This industry does not have a high number of suppliers across the large companies. This gives them leverage over companies as they do not have much competition to sign contracts with Personal Care companies. However, the supplier’s product, much like the company’s, does not have a high level of differentiation. This removes some of the power in the relationship.
Industry Rivalry: Medium/High
The level of competition in the industry is relatively strong. There is not an abundance of competitors which occupy the market. However, as mentioned before, switching costs and product differentiation are very low in this industry. Customer loyalty is relatively weak with the high level of price sensitivity in the industry. Additionally, as a goods-based industry, leaving the market would be expensive. This means there is not only a high ba
ier of entry and exit.
4. In a comparative analysis of profitability, KMB falls short of its industry averages. When looking at profit ratios: gross, operating, and net, KMB does not compare well to its peers. Looking at its peripherals, there is evidence to back this up. Sales growth has been weak, at best. Only once in the past decade have, they grown more than 5% in one fiscal year. From 2012 to 2017, they experienced either decline or growth less than 1%. One ratio that is a major outlier for leverage is LT Debt/Equity. The company has a large amount of long-term debt with negative shareholders equity, creating the large negative ratio. Additionally, they ca
y higher LT Debt to Capital and Asset ratios than the industry averages. This can be attributed to the high level of debt they ca
y, again. Additionally, compared to industry peers, they tend to have much less value in equity and are much more levered. Compared to their peers, KMB’s liquidity ratios perform worse. This can be seen in their tandem with their high levels of debt and an indication of inability to afford their assets. This is exace
ated with their very low cash ratio showing a low amount of cash on hand and a weak ability to cover assets. Their efficiency ratios, much like the rest, fall short of industry averages. This is reflected in some of the metrics previously discussed: slow sales growth, high cost of goods sold, and a relatively high level of assets.
5. When looking at ROE through DuPont Analysis, there is a clear KMB’s balance sheet produces an abnormally large ROE. KMB holds a very small amount of shareholder’s equity on their balance sheet. This, in turn, produces a ROE which is over 1700% in 2019. This number is not realistic as it is not reasonable to expect their net return on assets to be this large. For reference, the Personal Care industry produced a ROE of 26.1%. This can be attributed to KMB’s highly levered position, holding a lot of debt and not much stock offerings. This is especially true over the previous five years as their ROE was 616% while the industry stayed relatively consistent with a ROE of just 25.8%. These numbers jump out as for both 2019 and the five-year average, there is similar profit margins and KMB has a slightly higher asset turnover. The main difference is the large disparity in Return on Assets which KMB has a large ratio compared the industry.
Part B
· The five major relative valuation ratio i.e. Price to Earnings Ratio, Price to Book Ratio, Price to Cash flow, Enterprise Value to EBITDA and Enterprise Value to Sales Ratio has been presented as under:
Yellow column represents 5-year average, blue represents 5 year low and red represents 5 year high.
On the other hand, the industry performance for similar period has been lower as compared to Kimberly Corporation. The industry average stood higher for P/E implying that the company is undervalued in terms of industry and more prospects are available for rise in share price.
Further, EV to EBITDA ratio is poor as compared to the industry average. Also, the Price to Book Value ratio of company is negative. Thus, once can clearly state that company is overvalued in this front as equity of company is negative which market value is very high.
· Based on range of valuation ca
ied out above in relation to Kimberly Clark Corporation, a view may be taken that the share price of the company is overpriced as the company has negative net worth in its books and the market multiples are higher as compared to industry. Also, Discounted Cash Flow analysis share price value is lower than the cu
ent market price of the shares of the company. Hence it is advised to sell the shares of the company.
Equity Valuation Project
Objective:
The objective of this project is to introduce students to the top-down valuation approach. Each group is to choose one of the dividend paying stocks from the previous project, and conduct: i) macroeconomic and industry analysis, and ii) company valuation to prepare a stock report with buy, sell, or hold recommendation. In the process, students will get familiarized with various analyst reports. Stock selection guidelines in the previous project were aimed to ensure the appropriateness of the valuation models used in the project.
Content of the report:
A. Macroeconomic and industry analysis:
1) Identify the cu
ent economic conditions, supported by data. What are the implications of the cu
ent economic conditions on the industry that your firm operates in? Discuss the sensitivity of the firm’s industry to the business cycle. Any statement should have data supporting it. (10 points) (in word report)
2) Provide an evaluation of the industry life cycle and prospects for industry growth. Your evaluation of the life cycle should be supported by data, not opinion. Be consistent i.e. do not call an industry mature and mention it is going through massive growth. (10 points)