Proctor & Gamble Co. (PG, Financial) and Kimberly-Clark Corp. (KMB, Financial) have been in a heated battle for dominance of the multibillion-dollar diaper market for years. In the United States, which represents the largest market worldwide, P&G has 44% of the market share while Kimberly-Clark has 37%.
Currently, the importance of the diaper market to P&G cannot be overstated considering the company reported market share declines in each of its five core product categories in the past year. In addition, of P&G’s 21 consumer brands generating more than $1 billion in annual sales, none is more important than Pampers diapers. Last year, the diaper franchise alone brought in $9 billion in sales, which was about 13% of the company’s total sales.
For Kimberly-Clark, it is also just as important. As a matter of fact, due to the aggressive ongoing price war with P&G in the diaper market, the company’s top and bottom lines have been taking significant hits. It appears this may continue going forward. The manufacturer of Huggies diapers was forced to lower guidance on a number of metrics due to weaker demand for its core diaper products.
According to Kimberly-Clark, “Huggies diaper and adult care volumes were down low single-digits and mid-single digits, respectively, compared to double-digit growth in the year-ago period that included benefits from innovation launches and increased promotion shipments. Adult care volumes in 2016 were also impacted by competitive promotion activity.”
The company now expects earnings per share to come in at $5.92 to $6.05, down from the $5.92 to $6.15 it had previously forecasted.
While the diaper market may seem pretty clean-cut at first glance, there are a number of interesting dynamics at play that investors should keep in mind. The major driving themes of the market have changed slightly over the past two years, but it has forced these two rivals to rethink their strategies.
For some time now, the growth of the diaper market was propelled by the Westernization of lifestyles and the subsequent replacement of cloth diapers with disposable variants in developing regions. In the U.S, parents were avoiding the more expensive training pants-style diapers to save money compared to the rising middle class parents in China and Eastern Europe, who fueled the demand for higher-end diapers like Kimberly-Clark’s Huggies.
Bernstein Research analyst Ali Dibadj noted, “P&G has benefited in recent years from a strong value play – LUVs in a value-conscious U.S market while K-C’s Huggies has been hurt by its relatively premium positioning while in China and Eastern Europe, Huggies’ relatively strong upscale product mix has been just right.”
For the most part, I believe these themes could have already played out and new ones are coming into the picture.
One major emerging theme is consumer packaged goods companies are increasingly turning to the use of e-commerce platforms to boost sales. According to data analytics firm 1010data, e-commerce sales of consumer packaged goods grew 42% in 2015, well ahead of overall growth in e-commerce and driven heavily by Amazon (AMZN) subscription sales, which more than tripled.
As such, it is no surprise that e-commerce opens the door for more intense competition since it allows other rivals to challenge the market leaders more effectively using the subscription model. For instance, in a press release earlier this year, Bemax Inc. (OTC: BMXC) – a distributor of private label disposable baby diapers announced that it would be launching on Amazon as part of its first phase of penetrating the U.S market.
Although this may not sound like a big deal, for a company that made $538,738 in revenue for FY2015, this could be a potential game changer for Bemax. This is due to the fact that a report from McKinsey predicts that online sales are expected to account for 10 to 30 percent of CPG industry sales in the next five years and considering that the company also has its own ecommerce platform, this certainly bodes well for it.
Moreover, the report from 1010data further showed that baby diapers ranked in the top 10 CPG categories with the biggest YOY growth in ecommerce sales at 61 percent. Bemax now expects revenue for the year to come in at between $2.73 million to $3.3 million thanks in part due to the prevalence of ecommerce. While the company only represents a small part of the highly fragmented competition fighting it out for the remaining roughly 30 percent market share not yet under K-C’s or P&G’s control, it illustrates my broader point that CPG companies are waking up to the opportunity fueled by ecommerce.
The market leaders have not been lagging behind either. P&G e-commerce sales are now at $3 billion. The company expects China e-commerce will account for 30% of sales, which it forecasts will exceed $1 billion this year. Kimberly-Clark also stated last year that e-commerce was proving to be an important source of sales and it saw a significant amount of incremental growth coming through such platforms.
"We have a pretty well-developed e-commerce business in Asia and we're working very closely with all the e-commerce players," Anthony J. Palmer, president of global brands and innovation at Kimberly-Clark, said. "We see them as very important customers."
Another changing trend observed over the last half of the past year is U.S consumers are changing their spending habits and are willing to spend more on training pants. During P&G’s most recent quarter, the company noted that since it introduced the new Pampers Easy Ups training pants in the U.S., the segment has grown by 16% with Pampers share increasing over four points. Kimberly-Clark also reported that training pants made a major improvement in 2015. The company saw double-digit consumption growth, which carried through to 2016.
While these themes are in no way exhaustive, when it comes down to it, the main question that is likely on most investors’ minds is which of the two market leaders would be a better buy. Both have fairly predictable cash flows and offer investors a similar dividend yield of around 2.9%. With regards to valuation, P&G has a price-earnings (P/E) ratio of 16.4, which is less than its five-year average of 22.1 and is also cheap compared to the industry average of 20. On the other hand, Kimberly-Clark has a P/E ratio of 22.1, which is also lower than its five-year average of 28.5.
Over the past three months, Kimberly-Clark has gained 16%, outperforming both P&G’s 7% gain and the broader S&P 500‘s gain of 3%. As such, I think investors with a long-term perspective would be better off with P&G at current price levels or should wait for a pullback to provide a better entry point for Kimberly-Clark.
Disclosure: I do not own stock in any of the companies mentioned.
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