Does Royal Baby Mean Royal Profits?

Gerelyn is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It's impossible to watch the news without hearing the royal buzz surrounding Prince William and Kate Middleton's new baby boy. Whether you care or not, it's hard not to feel some joy at the thought of a new and healthy baby being brought into the world. And whether or not the royal news gives way to a new baby boom, you can't ignore that the world population is growing. A growing population coupled with higher standards of living in emerging countries could translate into greater performance for the makers of baby products. 

Kimberly-Clark (NYSE: KMB), the brand behind Huggies diapers, reported second-quarter earnings of $526 million, up nearly 6% from the year-ago period. Diluted EPS climbed by a dime to $1.36 per share. Excluding charges tied to its European exposure (where Kimberly-Clark is exiting some lower-profit businesses), earnings surpassed analyst estimates by $0.02 at $1.41 per share. Revenue came in virtually flat at nearly $5.3 billion, which was slightly less than analyst estimates.  

Baby steps

In North America, Huggies Baby Wipes were a bright spot for the company, but couldn't prevent an overall decline in the personal care division, which experienced a sales decline of 3%. Weakness stemming from diaper volumes and Little Swimmers swim pants weighed on results. While overall European sales fell 29%, organic sales volumes climbed 8% amid strength stemming from baby wipes and child-care products -- but not diapers. 

Incidentally, Kimberly-Clark is pulling the plug on its European diaper business, where it's implementing workforce reductions. With the exception of Italy, it has already stopped selling Huggies in all European markets. 

Emerging market growth

While diaper demand in North America was weak, Kimberly-Clark's international business saw 9% overall growth driven largely by the diaper business. Diaper volumes were up 45% in China and 10% in both Russia and Brazil. Indeed, if things have bottomed in China, Kimberly-Clark will begin to experience the benefits, which could offset a slowdown that's unfolding in some of the more "developed" developing markets, including Australia and Korea. 

The company has some planned innovations to be unveiled in the third quarter that could drive shares higher. It also faces more friendly comps in the second half of the year, so all things considered, the best is yet to come. These tailwinds might be priced into the stock, however, as shares are trading at a P/E of around 21.   

To be clear, it's still up against formidable currency headwinds that are eating into revenue and subsequently profits, not to mention commodity cost inflation. But its focus on cost-cutting and innovation could be the saving grace. 

Kimberly-Clark upheld its full-year 2013 guidance, calling for EPS of between $5.60 and $5.75. Currency rates are expected to drag on sales by as much as 2%. Kimberly-Clark is also in the midst of a restructuring and expects to achieve cost savings of between $300 million to $350 million, which could offset some of the currency headwinds.

Child's play

Diaper brand Pampers is Procter & Gamble's (NYSE: PG) largest brand and contributes about $10 billion in annual sales. But P&G is heavily exposed to the international markets, and like rival Kimberly-Clark faces the same currency and cost-inflation headwinds.

When P&G reports its fourth quarter earnings on August 1, it should provide greater clarity on how the company is managing the currency impact stemming from regions including Venezuela, Argentina, and Egypt. It's also not immune to the headwinds in Western Europe but could capitalize on Kimberly-Clark's exit from the diaper business to increase its market share in this region. 

The baby care and family care segment contributes 19% of sales and also about one-fifth of earnings. P&G has 35% of global market share in baby-care products, according to the company's own annual report.  As of June 2012, P&G had $29.8 billion in total debt. It reported $13.3 billion in operating cash flow in 2012 including $9.3 billion in free cash flow. This year, the company has lifted its dividend by 7% and share-buyback program to $6 billion.

At the end of the current fiscal year, developing markets are expected to contribute about 40% P&G's total sales and the company is still focused on growth in BRIC (Brazil, Russia, India and China) regions. While the developing market footprint is double the contribution from a decade ago, it lags some of P&G's competitors. P&G's baby care segment has been weak in the North American and Western European markets, and considering that developed markets account for lion's share of its revenue, this is a "disproportionate" area of focus this year, according to P&G's annual report. 

One of P&G's highly popular products proved not to be kid-safe. P&G's Tide Pod laundry detergent product is expected to deliver some $500 million in sales for its first year from the U.S. alone. The company, however, had to scramble to change the translucent product packaging as kids have mistakenly taken the detergent pouches for candy, according to the American Association of Poison Control Centers and a report in The Wall Street Journal.  

Eyes on China

A discussion on babies wouldn't be complete without Johnson & Johnson (NYSE: JNJ). The pharmaceutical giant's consumer segment generated $14.4 billion in sales in 2012, including a $2.2 billion contribution from baby care. In 2012, sales performance in the baby care segment took a 4% hit from 2011 levels amid currency headwinds. 

Earlier this year, it acquired Shanghai Elsker for Mother & Baby in China, a company that makes and distributes baby-care products. No doubt the acquisition was an attempt to solidify Johnson & Johnson's foothold in the region, where the retail baby and child skin-care market is rising and pegged to exceed $765 million by 2016, according to Euromonitor International cited in China Daily. Shanghai Elsker generated some 500 million yuan ($81 million) in revenue last year, according to China Daily. 

With second-quarter sales of $17.9 billion, an 8.5% increase over last year's period, Johnson & Johnson continues to feel the negative impact from currency exchange rates. International baby care sales advanced 1.7% in the quarter but were weakened by the negative currency impact.  If those pressures persist, it expects foreign exchange headwinds to reduce full-year sales growth by as much as 2%.  

Conclusion

Buckingham Palace is probably stocking up on diapers but unfortunately for Kimberly-Clark, it won't be the Huggies brand. Kimberly-Clark's exit from Europe gives P&G an advantage and sales performance in the region will be something to watch. Of the three companies, Johnson & Johnson has the lowest forward P/E ratio and has solidified its position in China. Currency issues notwithstanding, I'd be comfortable adding shares at these levels.  

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Gerelyn Terzo has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson, Kimberly-Clark, and Procter & Gamble. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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