KIMBERLY CLARK DE MEXICO Re-Rating Completed; Downgrading to Hold

Transcription

1 Latin American Equity Research Mexico City, November 20, 2006 KIMBERLY CLARK DE MEXICO Re-Rating Completed; Downgrading to Hold Joaquín Ley* Mexico: Santander Banco Santander S.A. 5255) Company Report Mexico Consumer HOLD (11/15/06) CURRENT PRICE: US$4.51/M$48.90 TARGET PRICE: US$4.40/M$51.00 What s Changed Rating: From Buy to Hold Price Target: Introducing US$4.40 for YE07 EBITDA Estimates (US$): 06 From 660 Mn To 601Mn 07 From 721 Mn To 649 Mn 08 Introducing 708 Mn Company Statistics Bloomberg KIMBERA MM 52-Week Range (US$) E P/E Rel to IPC Index (x) E P/E Rel to Retail (x) NA IPC (US$) 2,244 3-Yr CAGR (05-08E) 11% Market Capitalization (US$ Mn) 5,180 Float (%) 52 3-Mth Avg Daily Vol (US$000) 2,990 Shares Outst Mn 1,148 Net Debt/Equity (x) 0.3 Book Value per Share (US$) 0.88 Estimates and Valuation Ratios E 2007E 2008E Net Earn (M$) 2,906 3,501 3,874 4,407 Current EPS Net Earn (US$ Mn) Current EPS P/E (x) P/Sales (x) P/CE (x) FV/EBITDA (x) FV/Sales (x) FCF Yield (%) 6.4% 11.1% 4.2% 5.7% Div per Share (US$) Div Yield (%) 4.3% 4.5% 8.3% 4.5% NA not available. Sources: Bloomberg, Company reports, and Santander Investment estimates. Investment Thesis: We are downgrading our rating on Kimber s shares to Hold from Buy following the stock price s recent rally (up 16% in U.S. dollars since October 2, 2006). The rally has led to valuation levels which, in our opinion, already fairly reflect the company s fundamentals as a pure consumer play after the divestiture of the industrial business. Trading at a 2007E P/E of 15.4 times, Kimber represents only a 6% discount to Kimberly Clark Corporation, and represents a 13% discount to the average 2007E P/E multiple for Kimberly Clark Corporation, Procter and Gamble, and Colgate and Palmolive. This discount was higher than 30% at the beginning of Relative to its historical valuation, Kimber is trading at a 12MF FV/EBITDA of 8.4 times, 31% above its last four years average of 6.4 times, and marking an all-time high. As we see it, this is a reflection of Kimber s new valuation standards as a pure consumer play in Mexico. We are introducing our year-end 2007 target price of M$4.40 per share (M$51.00 per share). We will no longer refer to our year-end 2006 target price of US$3.70 (M$43.50). Our target price implies a downside potential in U.S. dollars of 2.5% from current levels. However, the total return would be 6.9% (the total return we expect for the IPC Index is 3.2% including dividends). This represents a dividend yield of 9.4%, which includes the last installment of the 2006 dividend to be paid on December 6, the ordinary 2007 dividend, and the extraordinary dividend deriving from the proceeds of the divestiture of the industrial division. We believe that the amount of the extraordinary dividend could be announced before year end (we are assuming a payout of US$200 million). Reasons for Change to Estimates: We have lowered our 2006 and 2007 EBITDA estimates from US$660 million and US$721 million, to US$601 million and US$649 million respectively, to reflect the divestiture of the industrial products division. In addition, we are introducing our 2008 forecast of US$708 million. Valuation and Risks to Investment Thesis: Our year-end 2007 target price stems from a DCF analysis, implying a target 12MF FV/EBITDA multiple of 7.6 times, 10% below its current level, but slightly above the +2SD for the last four years average. Risks to our investment thesis include poorer-than-expected real pricing, weaker-than-anticipated volume, higher-than-expected pulp prices, and weaker-than-expected FX. * Employed by a non-us affiliate of Santander Investment Securities, Inc. and is not registered/qualified as a research analyst under NASD rules.

2 Re-Rating Completed; Downgrading to Hold Kimberly Clark de Mexico (Kimber) is the largest Mexican manufacturer and distributor of consumer and institutional tissue. 93% of the sales are domestic, while 7% are exports. In September 2006, Kimber sold its industrial products business (writing and printing paper, notebooks and cigarette paper, which represented 18% of total revenues in 2005) for US$434 million, to a trust where Eton Park and Impulsora de Desarrollos Estrategicos have a 60%, stake while Kimber holds the remaining 40%.The proceeds of the operation will be used for paying an extraordinary dividend, increasing the share buy back and finance capital expenditures. Kimberly Clark Corporation holds 48% of the total outstanding shares. We consider the remaining 52% as free float. VALUATION Kimber s share total return (including dividends) year-to-date is of 31% in U.S. dollars. This positive performance (which accelerated over the past few weeks) has led to a valuation level, which we consider as a fair reflection of Kimber as a pure consumer play after having divested from its industrial products division last September. In terms of 12MF FV/EBITDA, Kimber is trading at 8.4x, 31% above its last four years average, reaching an all time high. Again, we believe that the new Kimber deserves a higher valuation than the old Kimber with commodity exposure, owing to a number of reasons: (1) The tissue paper industry grows in volume two to three times GDP, while the industrial paper is more like one times. Therefore, as a pure consumer company, Kimber should post faster growth rates going forward. (2) Within the different products categories in which it participates in the consumer tissue industry, Kimber has market shares of above 50%, providing the company with a significant pricing power that it lacked in the industrial business, where its market share was 35%. (3) Margins and return on investment are higher in the consumer business. In 2005, the EBITDA margin of the consumer business was 33% versus 22% the industrial business. Also, we are expecting a 35% ROE for 2007 for Kimber being a pure consumer play versus the 25% recorded in 2005 when it still had the industrial business. Figure 1. Kimber 12-Month Forward FV/EBITDA Multiple, January 2003 to Date SD 7.5 Current Average SD SD 5.9-2SD Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Sources: Kimber, Mexican Bolsa, and Santander Investment. The discount to its U.S. peers has narrowed substantially. Trading at a 2007E P/E of 15.4x, Kimber presents a discount of 13% to a sample of U.S. U.S. consumer names encompassing Kimberly Clark Corporation, Procter and Gamble, and Colgate and Palmolive. This discount was of about 30% at the beginning of Also, on a 2007 basis it seems that U.S. companies have a higher net profit growth potential than Kimber. 2

3 Figure 2. Kimber Valuation Comps with International Peers, as of November 15, 2006, (2006E-2007E) FV/EBITDA P/E EBITDA Growth Net Inc Growth 2006E 2007E 2006E 2007E 2006E 2007E 2006E 2007E Kimberly Clark Corp % 6% 14% 4% Procter & Gamble % 8% 41% 11% Colgate & Palmolive % 9% 18% 10% Peers Average % 8% 33% 10% Kimberly Clark Mex % 8% 16% 6% KCM vs Peers Avg -25% -21% -16% -13% Sources: Bloomberg, IBES, and Santander Investment estimates. Based on a discounted cash flows analysis, we set our target price for year-end 2007 at US$4.40 per share. We calculated a WACC of 9.0% stemming from a cost of equity of 10.1% (equity risk premium of 5.5%, beta of 0.79, and risk-free rate of 5.8%), and an after-tax cost of debt of 6.6%. As capital structure, we assume 68% equity/32% debt. The perpetuity growth rate considered is 2.0%. Our target price implies a target 12MF FV/EBITDA multiple of 7.6x, 10% below its current level but still slightly above the +2SD. Figure 3. Kimber Free Cash Flow, 2008E-2017E (U.S. Dollars in Millions) 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E EBIT Tax Rate 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% NOPLAT Depreciation Changes in WC Capex Deferred Liabilities FCF WC: Working Capital. Source: Santander Investment. Figure 4. Kimber Discounted Cash Flow, 2008E-2017E (U.S. Dollars in Millions) 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E Residual Discount Rate 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% Discounted cash flows ,899.6 NPV of Cash Flows 2,410.1 Additions Deductions Target Market Cap 5,047.7 Current Market Cap 4,131.5 Target Price 4.40 Current Price 4.51 Note: Additions include cash and investments in non consolidated subsidiaries. Deductions include debt and minorities. Source: Santander Investment. Positives Faster growth and higher returns following the divestiture of the industrial business. Sound dividend policy. Good stock liquidity. Concerns Pulp prices still rising. Potential stiffer competition. High valuation. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

4 Re-Rating Completed; Downgrading to Hold RISKS TO INVESTMENT THESIS Risks to our investment thesis include a poorer-than-anticipate real pricing and/or sales mix, higher-than-expected cost inflation, more aggressive-than-anticipated marketing campaigns, which could negatively affect SG&A, and more intense competition from SCA (a Swedish tissue paper company). MACROECONOMIC PROJECTIONS Figure 5. Mexico Select Economic Projections, F F 2007F Real GDP (%) 4.2% 3.0% 4.5% 4.0% CPI Inflation (%) 5.2% 3.3% 3.8% 3.7% US$ Exchange Rate (Year-End) US$ Exchange Rate (Average) Interest Rate (Year-End) 8.5% 8.2% 7.0% 6.5% Interest Rate (Average) 6.8% 9.2% 7.2% 6.7% Fiscal Balance (% of GDP) -0.3% -0.2% 0.0% 0.0% Current Account Balance (% of GDP) -1.0% -0.6% -0.3% -0.8% International Reserves (US$ Bn) Total External Debt (% of GDP) 20.4% 16.8% 13.3% 12.8% Source: Santander Investment historicals and forecasts. EARNINGS REVISIONS Figure 6. Kimber Changes to 2006 and 2007 Estimates (Figures in Millions of U.S. Dollars) 2006E 2007E 2008E Current Previous Var % Current Previous Var % Introducing Revenues 1, , % 1, , % 2,100.8 EBITDA % % EBITDA Mg 32.7% 31.3% 5% 33.4% 31.3% 7% 33.7% Net Income % % EPS % % 0.32 Source: Santander Investment. We have revised downward our 2006 and 2007 estimates on the back of the divestiture of the industrial products division, which represented 18% and 13% of Kimber s sales and EBITDA in 2005, respectively. Our net profit estimate for 2006 still incorporates the industrial business as a discontinued operation (it was effectively sold in late October), while in 2007, it only reflects the income corresponding to the 40% stake that Kimber is expected to maintain in that business. 4

5 2007 EARNINGS OUTLOOK We expect Kimber s revenues to grow 7% in real peso terms year on year in 2007, supported by an 8% volume growth in the domestic business and a slight real price gain. Kimber plans to implement a 4% price increase in late 2006, which for practical purposes should be effective in early This should more than compensate for the expected inflation of 3.7% for No further price increases have been announced for next year, although we would not rule them out. However, we expect a steep drop of the export business (15% to 20%). Since capacity utilization levels are quite high (well above 90%) we believe Kimber might well decide to serve the growing domestic demand in order not to lose market share with volumes so far destined to the export market. With regard to this, Kimber plans to invest US$350 million within 2007 and 2008 in order to expand primary capacity of tissue paper by 20% through adding 70,000 tons. Half of that additional capacity will become operational by December 2007 and the other half by 3Q08, according to management. We expect EBITDA to grow 9%, supported by the expected revenue increase and a 70-basis point EBITDA margin expansion. We expect pulp prices to reach a peak by year-end 2006, and start falling after that. In any case, we expect the NBSK pulp (the one we use as a reference for Kimber) average price for 2007 to be still slightly above (1%) of According to Patrick Conrad, our pulp and paper analyst, between 2005 and million tons of pulp production capacity will be added worldwide, equivalent to 14% of the global demand in He expects global demand to grow by no more than 2% annually within that period of time. Therefore, an oversupply situation would be foreseeable in the near future. At the same time, most of the new capacity will imply a migration from less competitive regions in terms of production costs (North America and Europe) to more cost efficient regions (particularly Latin America). Thus, Patrick believes that not only an oversupply situation but also more efficient producers will put pressure on international pulp prices going forward. We base our expectation for a margin expansion on slight real price increases, increased operating leverage and a reduced weighting of the export business (carrying lower margins) in Kimber s consolidated figures. Finally, we anticipate Kimber s net profit to grow by only 7%, negatively affected by the divestiture of the industrial business. Excluding this effect, we estimate that the growth would be close to 15%. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

6 Re-Rating Completed; Downgrading to Hold FINANCIAL STATEMENTS 6 Figure 7. Kimber Income Statement, Balance Sheet, and CF Statement, E (U.S. Dollars in Millions) Income Statement 2005 % 2006E % 2007E % 2008E % Sales 2, , , , Cost of Sales -1, , , , Gross Profit Oper. and Adm. Expenses Operating Profit Depreciation EBITDA Financing Costs Interest Paid Interest Earned Monetary Gain/Loss FX Gain/Loss Other Financial Operations Profit before Taxes Tax Provision Profit after Taxes Subsidiaries Extraordinary Items Minority Interest Net Profit Balance Sheet 2005 % 2006E % 2007E % 2008E % Assets 2, , , , Short-Term Assets Cash and Equivalents Accounts Receivable Inventories Other Short-Term Assets Long-Term Assets Fixed Assets 1, , , , Deferred Assets Other Assets Liabilities 1, , , , Short-T. Liabilities Suppliers Short-Term Loans Other ST Liabilities Long-Term Loans Deferred Liabilities Other Liabilities Majority Net Worth 1, , , , Net Worth 1, , , , Minority Interest Cash Flow E 2007E 2008E Net Majority Earnings Non-Cash Items Changes in Working Capital Capital Increases/Dividends Change in Debt Capital Expenditures Net Cash Flow Beginning Treasury Ending Treasury Sources: Company reports and Santander Investment estimates.

7 Figure 8. Kimber - Income Statement, Balance Sheet, and CF Statement, E (Millions of Nominal Pesos) Income Statement 2005 % 2006E % 2007E % 2008E % Sales 21, , , , Cost of Sales -13, , , , Gross Profit 8, , , , Oper. and Adm. Expenses -2, , , , Operating Profit 5, , , , Depreciation 1, , , , EBITDA 6, , , , Financing Costs Interest Paid Interest Earned Monetary Gain/Loss FX Gain/Loss Other Financial Operations Profit before Taxes 4, , , , Tax Provision -1, , , , Profit after Taxes 2, , , , Subsidiaries Extraordinary Items Minority Interest Net Profit 2, , , , Balance Sheet 2005 % 2006E % 2007E % 2008E % Assets 24, , , , Short-Term Assets 8, , , , Cash and Equivalents 1, , , , Accounts Receivable 4, , , , Inventories 1, , , , Other Short-Term Assets Long-Term Assets Fixed Assets 16, , , , Deferred Assets Other Assets Liabilities 13, , , , Short-T. Liabilities 5, , , , Suppliers 2, , , , Short-Term Loans Other ST Liabilities 2, , , , Long-Term Loans 5, , , , Deferred Liabilities 2, , , , Other Liabilities Majority Net Worth 11, , , , Net Worth 11, , , , Minority Interest Cash Flow E 2007E 2008E Net Majority Earnings 2, , , ,407.2 Non-Cash Items , ,156.6 Changes in Working Capital Capital Increases/Dividends -3, , , ,350.4 Change in Debt Capital Expenditures , , ,089.3 Net Cash Flow , , Beginning Treasury 2, , , ,776.1 Ending Treasury 1, , , ,627.3 Sources: Company reports and Santander Investment estimates. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

8 Re-Rating Completed; Downgrading to Hold IMPORTANT DISCLOSURES KCM 12-Month Relative Performance (U.S. Dollars) IPC Kimber Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Aug-06 Sep-06 Oct-06 Nov-06 Sources: Bloomberg and Santander Investment. KCM Three-Year Stock Performance (U.S. Dollars) B $3.20 9/27/04 2,100 1,900 Analyst Recommendations and Price Objectives H $2.74 9/23/03 B $3.08 7/16/04 B $3.70 8/22/05 1,700 1,500 1,300 1, SB: Strong Buy B: Buy H: Hold UP: Underperform S: Sell UR: Under Review S-03 D-03 M-04 J-04 S-04 D-04 M-05 J-05 S-05 D-05 M-06 J-06 S Kimberly-Clark (L Axis) IPC (R Axis) Source: Santander Investment. 8

9 Key to Investment Codes IMPORTANT DISCLOSURES (CONTINUED) Rating Definition Strong Buy Expected to outperform the local market more than 15%. Buy Expected to outperform the local market 5%-15%. % of Companies Covered with This Rating % of Companies Provided Investment Banking Services in the Past 12 Months 57.55% 77.78% Hold Expected to perform within a range of 5% above or below the local market % 16.67% Underperform Expected to underperform the local market 5%-15% % 5.56% The numbers above reflect our Latin American universe. For a discussion, if applicable, of the valuation methods used to determine the price targets included in this report and the risks to achieving these targets, please refer to the latest published research on these stocks. Research is available through your sales representative and other electronic systems. Target prices are 2006 year-end unless otherwise specified. Recommendations are based on a total return basis (expected share price appreciation + prospective dividend yield) unless otherwise specified. Stock price charts and rating histories for companies discussed in this report are also available by written request to Santander Investment Securities Inc., 45 East 53 rd Street, 17 th Floor (Attn: Research Disclosures), New York, NY USA. Ratings are established when the firm sets a target price and/or when maintaining or reiterating the rating. Ratings may not coincide with the above methodology due to price volatility. Management reserves the right to maintain or to modify ratings on any specific stock and will disclose this in the report when it occurs. Valuation methodologies vary from stock to stock, analyst to analyst, and country to country. Any investment in Latin American equities is, by its nature, risky. A full discussion of valuation methodology and risks related to achieving the target price of the subject security is included in the body of this report. The benchmark used for establishing Argentina recommendations is our forecast of the year-end Argentina IFCI index. For the Andean countries, our benchmark is the simple average of the country risk of each country plus the 10 year U.S. T-Bond yield plus 5.5% of equity risk premium. For additional information about our rating methodology, please call (212) This report has been prepared by Santander Investment Securities Inc. ( SIS ) (a subsidiary of Santander Investment S.A., which is wholly owned by Banco Santander Central Hispano, S.A. ("Santander"), on behalf of itself and its affiliates (collectively, Grupo Santander) and is provided for information purposes only. This document must not be considered as an offer to sell or a solicitation of an offer to buy any relevant securities (i.e., securities mentioned herein or of the same issuer and/or options, warrants, or rights with respect to or interests in any such securities). Any decision by the recipient to buy or to sell should be based on publicly available information on the related security and, where appropriate, should take into account the content of the related prospectus filed with and available from the entity governing the related market and the company issuing the security. This report is issued in Spain by Santander Central Hispano Bolsa, Sociedad de Valores, S.A. (SCH Bolsa), and in the United Kingdom by Santander Central Hispano S.A., London Branch (Santander London), which is regulated by the Financial Services Authority in the conduct of investment business in the UK. This report is not being issued to private customers. SIS, Santander London, and SCH Bolsa are members of Grupo Santander. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed, that their recommendations reflect solely and exclusively their personal opinions, and that such opinions were prepared in an independent and autonomous manner, including as regards the institution to which they are linked, and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report, since their compensation and the compensation system applying to Grupo Santander and any of its affiliates is not pegged to the pricing of any of the securities issued by the companies evaluated in the report, or to the income arising from the businesses and financial transactions carried out by Grupo Santander and any of its affiliates: Joaquin Ley. The information contained herein has been compiled from sources believed to be reliable, but, although all reasonable care has been taken to ensure that the information contained herein is not untrue or misleading, we make no representation that it is accurate or complete and it should not be relied upon as such. All opinions and estimates included herein constitute our judgment as at the date of this report and are subject to change without notice. Any U.S. recipient of this report (other than a registered broker-dealer or a bank acting in a broker-dealer capacity) that would like to effect any transaction in any security discussed herein should contact and place orders in the United States with SIS, which, without in any way limiting the foregoing, accepts responsibility (solely for purposes of and within the meaning of Rule 15a-6 under the U.S. Securities Exchange Act of 1934) for this report and its dissemination in the United States by Santander Investment Securities Inc. All Rights Reserved. 2006