Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Kimberly Clark Corporation – Second Quarter of Fiscal 2021 Earnings IR Presentation

By Callum Turcan

In alphabetical order by ticker: INTC, GGG, KMB, STLD

Earnings season is upon us! Over the next few weeks, we should get a better idea of how corporations view the trajectory of the domestic and global economy now that coronavirus (‘COVID-19’) vaccine distribution efforts are well underway. We intend to cover the earnings reports of key companies across a range of industries and sectors in the coming weeks to provide a broad overview of how the economy fared during the end of calendar year 2020 and what to expect going forward.

Intel (INTC)

For starters, please be aware that we removed Intel Corporation (INTC) from the newsletter portfolios back in October 2020 (link here). The company, a long-time holding in the newsletter portfolios, was starting to fall behind the competition, namely Advanced Micro Devices (AMD). At the moment, our favorite semiconductor idea is Qualcomm Inc (QCOM), and interested members can read more about our thoughts on Qualcomm here. ASML Holding N.V. may also be worth a look.

Pivoting back to Intel, the company beat both consensus top- and bottom-line estimates in the fourth quarter of fiscal 2020 (period ended December 26, 2020), results released January 21. For the full fiscal year, Intel’s GAAP revenues grew 8% annually, supported by the work-from-home trend, which drove up demand for laptops and PCs along with strong data center demand as the shift towards cloud-computing accelerated last year. Intel’s GAAP operating income grew by 7% annually in fiscal 2020 as the chip giant invested more in its R&D activities to catch back up with the competition.

Most importantly, Intel provided an update on its embattled manufacturing operations which recently prompted a major management change. Intel announced in January 2021 that its current CEO, Bob Swan, will step down on February 15 to be replaced by Pat Gelsinger who has been serving as CEO of VMware Inc (VMW) since September 2012. During Intel’s latest earnings call management noted (emphasis added):

“Based on initial reviews, I am pleased with the progress made on the health and recovery of the 7-nanometer program. I am confident that the majority of our 2023 products will be manufactured internally.

At the same time, given the breadth of our portfolio, it's likely that we will expand our use of external foundries for certain technologies and products. We will provide more details on this and our 2023 roadmap once I fully assess the analysis that has been done and the best path forward.” --- Pat Gelsinger, incoming CEO of Intel

Intel has finally admitted that it will need to utilize third-party semiconductor fabrication facilities, known as “foundries,” to remain competitive in the space. Most of the company’s competitors utilize third-party foundries. The industry is already moving towards five-nanometer “chips” while Intel is having trouble scaling up its seven-nanometer chip production capabilities. Taiwan Semiconductor Manufacturing Company Limited (TSM) is a potential partner given its technological lead in the foundry space as the firm already offers five-nanometer chip production services.

In fiscal 2020, Intel generated $20.9 billion in free cash flow (inclusive of capital expenditures related to held for sale assets), and the company clearly remains a free cash flow cow. However, we became concerned that if it did not address its manufacturing issues promptly, Intel’s financial outlook could deteriorate significantly. Intel’s outlook for the first quarter of fiscal 2021 implies its revenues will decline by 12% year-over-year.

We are not looking back on our decision to remove Intel from the newsletter portfolios.

Graco (GGG)

Headquarters in Minneapolis, Minnesota, Graco Inc (GGG) sells fluid management systems and products that it designs and manufacturers. The firm’s GAAP revenues advanced 14% year-over-year in the fourth quarter of fiscal 2020 (period ended December 25, 2020), beating consensus estimates, with the company reporting strong growth in the Asia Pacific region and at its ‘Contractor’ business segment. Graco’s bottom-line performance in the fiscal fourth quarter beat consensus estimates as well.

For the full fiscal year, Graco’s GAAP revenues were marginally higher year-over-year due to its strong performance near the end of fiscal 2020. However, its GAAP operating income fell 8% year-over-year in fiscal 2020 due in large part to an impairment charge in the fiscal third quarter related to the sale of its U.K.-based valve business. In its earnings press release, management had this to say on Graco’s recent performance and outlook (lightly edited, emphasis added):

“Sales in the fourth quarter grew double digits on improving Industrial demand and continued strength in the Contractor segment… While several end markets remain soft, we saw improvements in our spray foam, electronics, battery and systems end markets during the quarter. Improvements in these markets coupled with continued robust sales in our professional paint and home center channels resulted in record quarterly sales. Thanks to the hard work of our employees, suppliers and distributors during a challenging 2020, we were able to stick to our playbook and fully fund our growth strategies…

Heading into 2021, we expect challenging end market conditions to remain in placefor at least the first half in many of our end markets as lockdowns continue… Our outlook for the Contractor segment remains positive as favorable conditions continue, and demand for our products is solid across major end markets and product categories.” --- Patrick McHale, President and CEO of Graco

Management noted that various quarantine measures currently in place worldwide to keep the pandemic contained would pose headwinds to Graco’s near-term performance, though it appears underlying demand for many of its products remains strong. Shares of GGG are currently trading at the upper end of our fair value estimate as of this writing and appear to be fully valued.

Kimberly Clark (KMB)

Maker of Huggies diapers and Kleenex tissues, Kimberly Clark Corporation (KMB) beat both consensus top- and bottom-line estimates when it reported its fourth quarter earnings for 2020. The company’s organic sales grew by 6% annually in 2020 with rising volumes contributing 400 basis points to its organic sales growth while price increases and product mix each contributed 100 basis points to that growth rate. Its ‘Consumer Tissue’ business operating segment played a key role in Kimberly Clark’s strong 2020 performance with the segment’s sales and operating profit both shifting higher by double digits on an annual basis last year.

Its GAAP net revenues grew by 4% year-over-year in 2020, with foreign currency headwinds offset by strong organic sales growth. Kimberly Clark’s GAAP operating income climbed higher by 8% year-over-year due to GAAP gross margin expansion and economies of scale, though restructuring expenses were a headwind. The company’s ‘2018 Global Restructuring Program’ aims to generate $540-$560 million in annualized pre-tax cost savings and management expects the program will be completed this year. However, to achieve those cost savings, Kimberly Clark expects to incur $2.0-$2.1 billion in pre-tax restructuring charges. As of its latest earnings report, the firm had already incurred ~$1.8 billion in pre-tax restructuring charges via this program.

Looking ahead, Kimberly Clark estimates its net sales will grow by 4%-6% annually in 2021. Annual organic sales growth is estimated at just 1%-2% with favorable expected foreign currency movements and its Softex Indonesia acquisition expected to drive most of Kimberly Clark’s net sales growth this year. It appears after a banner 2020, Kimberly Clark’s organic sales growth trajectory is expected to slow meaningfully going forward. Procter & Gamble Company’s (PG) management team noted that it was experiencing a deceleration of its organic sales growth in North America during the firm’s latest earnings call. Acquisitions will likely continue to play a big role in supporting sales growth at bigger consumer staples firms.

Kimberly Clark spent ~$1.2 billion in cash acquiring Softex Indonesia (about 80% of this company’s revenues came from diapers) through a deal that was completed in October 2020. The firm forecasts its adjusted operating profit (a non-GAAP measure) will grow by up to 2% year-over-year in 2021 as the favorable impact from its expected net sales growth and ongoing restructuring program will be largely offset by rising input prices and distribution expenses. Kimberly Clark’s adjusted EPS (another non-GAAP figure) is expected to reach $7.75-$8.00 in 2021, up from $7.74 in 2020.

Shares of Kimberly Clark are trading in the upper bound of our fair value estimate range as of this writing, indicating that KMB is fairly valued at this time. Management intends to continue pursuing meaningful share buybacks and dividend increases in 2021. Kimberly Clark had a ~$8.1 billion net debt load (inclusive of short-term debt) at the end of 2020, though we view its net debt burden as manageable given its strong cash flow profile. The company generated $2.5 billion in free cash flow in 2020 while spending $1.5 billion covering its dividend obligations and another $0.7 billion buying back its stock. Its Dividend Cushion ratio of 1.1 earns the firm a “GOOD” Dividend Safety rating. In our view, Kimberly Clark would be better served paying down its debt than buying back its stock.

Steel Dynamics (STLD)

On January 25, Steel Dynamics Inc (STLD) beat both consensus top- and bottom-line estimates when reporting its fourth quarter earnings for 2020. However, the steel maker’s free cash flows turned negative in 2020 due to its capital expenditures roughly tripling year-over-year. Steel Dynamics is building a new electric-arc-furnace (‘EAF’) flat roll steel mill down in Sinton, Texas, near the port of Corpus Christi which is expected to cost $1.9 billion to develop and is slated to be operational by the middle of this year. Management provided an optimistic outlook for 2020, noting in the earnings press release that (emphasis added):

“The automotive sector has experienced the strongest recovery, and the construction sector remains resilient. Customers are positive concerning the business outlook for 2021. We are seeing pent up demand, as steel service center and end-user inventories are still extremely low compared to historical norms. We also believe U.S. trade agreements and existing steel trade cases will continue to moderate steel imports. Based on strong domestic steel fundamentals, we are optimistic regarding the North American steel market dynamics and believe steel consumption will experience growth this year. We expect to see continued steel price strength and strong customer demand in 2021.” --- Mark Millett, President and CEO of Steel Dynamics

Steel Dynamics faced significant headwinds in 2020 due to the COVID-19 pandemic, particularly during the first half of the year. However, since then the industrial sector has staged an impressive rebound. The company reported that its GAAP operating income climbed higher by 42% year-over-year during the final quarter of 2020 due to favorable pricing movements, a product of rising steel demand and the impact that the idling of various steel mills had on inventory levels. According to Steel Dynamics, inventory levels remain low (it appears the firm is referencing steel inventories in North America). Steel Dynamics’ promising outlook reinforces our expectations that the North American economy will experience an impressive rebound from the pandemic-induced recession going forward.

In October 2019, Steel Dynamics’ credit ratings became investment grade, and the firm noted recent “refinancing activities have reduced its effective interest rate from 5.4% to 3.5%” in its earnings press release. We applaud management for its bet on US manufacturing and for taking advantage of the low interest rate environment via refinancing activities. Back in June 2020, we wrote an article covering Steel Dynamics that we encourage our members to check out (link here).

Concluding Thoughts

Fourth quarter 2020 earnings season is upon us. In this note, we walked through four companies issuing results. Intel is making the right call by seeking to outsource some of its production needs given its inability to produce certain current- and next-generation chips. For companies operating in the industrial sector, it appears that after a challenging first half of 2020, things are now recovering in earnest. The industrial economy appears to have entered 2021 with momentum, keeping short-term headwinds in mind. Consumer staples entities experienced strong demand growth in 2020, though it appears that many companies operating in the space now expect their organic sales growth to moderate in 2021 as the uplift from “pantry stockpiling” fades.

Members interested in reading more about our thoughts on the market should check out our recent ALERT: Bull Raids, Short Squeezes and Highly Unusual Market Activity article that can be viewed here.

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Related: GGG, INTC, KMB, PG, STLD, QCOM, VDC, VMW

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Callum Turcan does not own shares in any of the securities mentioned above. Qualcomm Inc (QCOM) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Vanguard Consumer Staples ETF (VDC) is included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.