The Wall Street view on tissue and consumer products

Ali Dibadj is a Senior Vice President and Senior Analyst at Sanford C. Bernstein in New York. As a financial analyst, he advises large institutional investors, including pension funds, where to place their money in the stock market. After numerous years as a consultant with McKinsey in the consumer products and retail areas, he began covering the consumer products stocks for Sanford C. Bernstein about eight years ago. Today he follows the big players in that sector such as Procter & Gamble, Kimberly-Clark, Estée Lauder, Coca-Cola and many others. We met with him to learn how he works and get an idea about how he assesses some of the big companies in the tissue business.


Hugh O’Brian

“Essentially a buy or sell recommendation is based on comparing my best analysis about what a company’s growth and earnings are going to do versus what the market seems to be expecting. To arrive at those conclusions, I compare three main inputs against what the main consensus is about the company. The three main inputs include 1. What the companies will give me including public filings and discussions with management; 2. What I learn at industry conferences and events, where I have broader discussions about the dynamics of the sector, and 3. Our own information network using internal sources as well as outside data like Nielsen numbers.


Comparing our analysis against the market consensus.
Using this information, we make a judgment if we think the companies are going to succeed based on their stated strategy for growth, cost-cutting, profitability etc. Then we compare our analysis with what the market is telling us and if we see better prospects, we make a buy recommendation. And if our analysis shows more negative prospects than the market is communicating, for example the market feels the company will grow by 10% but we feel it will only be 2%, we say sell. The key thing is judging whether our conclusion differs from what the general market information is saying.”
On the day before I was visiting him, Coca-Cola stock dropped by 8%, which is an enormous fall. Since Ali recommends Coke stock, he says “I didn’t sleep last night”.


What caused the drop?
Expectations were not met. The market was expecting much faster growth next year and much higher cost-cutting. Coke announced yesterday that both of those things were not going to happen as planned. That news came out and the stock crashed.”
Another factor that comes into validating a stock is whether there is truly potential to improve. “As an analyst, if I feel there is potential to improve their bottom line, then I am attracted to that stock. Of course I have to be confident that the management team in place can execute the required strategy to extract that potential. If so, a potential turnaround represents a good opportunity for stock price gains.”
“A lot of consumer products companies have to make the mindset change from growth to little growth. Making that transition is certainly possible to do profitably, but it often takes a very tough management mindset to cut costs in the right way while maintaining profitability and morale. When growth is very slow it must be done, because fighting for market share in a declining category is a silly, downward-spiraling price war.”


Tissue companies must take hard decisions.
Looking at the tissue sector, Ali says Kimberly-Clark represents the company that has slowly, but continuously, sharpened its focus on the highest value sectors. “It has sold its pulp and forest assets over the years, getting rid of low margin businesses and regions, and taking hard decisions to transform the company. It has left countries where it did not get acceptable profits, and most recently it spun off its healthcare business which was underperforming versus what had been expected. SCA of Sweden has gone through a very similar process of sharpening its focus in recent years. CMPC and a few others are going down that path too.”


North Americavery competitive, with lots of premium capacity.
“Tissue markets today are tough. In North America there is a lot of good money chasing bad with enormous amounts of new capacity coming on stream.
Everyone believes that, compared to other paper grades, tissue is more attractive so they all say ‘let’s go there. The tissue market is not shrinking like it is for printing papers.’ But it’s only growing 1%, in line with population growth, and there are too many people coming in.”
“As new players rush in, established players try to defend market share, and downward price pressure builds as they compete. The party has become rather crowded with some players cutting prices massively to protect their market share. Eventually we will reach a price equilibrium but older, less-efficient capacity has to come out in North America for that to be reached. Usually the precursor of capacity being shutdown is a very tough competitive environment, like we are seeing now.”
“The crux of the problem is that almost all the new capacity is focused on the high-end premium-quality segment of the market. And it is generally private label product, but the quality is much higher than the old private label. TAD or TAD-like quality private label product is available at extraordinarily low prices today so this protected TAD domain that only Procter & Gamble, Kimberly-Clark and Georgia-Pacific previously had is open to others. Quite frankly if you don’t have a diversified product portfolio outside tissue today you face extraordinary pressure. GP has been losing share and has cut prices in reaction to that, and the others must follow. So I think more capacity will be shut down in the coming year, there is no other option.”


Does tissue really fit K-C and P&G?
“Looking more broadly, we feel the consumer tissue business doesn’t fit the personal care business for Kimberly-Clark all that well. They’ve gone through many iterations of divesting different businesses with the healthcare division recently being spun off. The original idea with healthcare in K-C was that they are selling lots of tissue and absorbent products to hospitals, so why not go up the sophistication curve and use those channels to sell disposable gowns, tubes, etc.. but it really didn’t work out as planned, hence the spinoff.”
“An even bigger question is at Procter & Gamble where consumer tissue is only a US business. And that business does not have the growth trajectory it previously did; now it’s facing a slowdown. It’s about a US$5 billion business that is growing slowly so it really weighs down their corporate growth and their ROIC (return on invested capital). It’s a heavy business for them as far as manufacturing assets and capital investments required, compared to almost any other sector they are in.”
“Our view, for a long time, has been that P&G should do just like they did in Europe and get rid of their US tissue business. The challenge will be finding a buyer that is willing to pay the high price P&G must ask considering its tax base for the tissue business is essentially zero since they have built it organically. So they will have a very large tax bill for the capital gain and therefore need a high price to justify selling it.
The tissue business drives a lot of cash flow but from a strategic perspective I don’t know that it fits Procter & Gamble. Perhaps they’ll spin it off as a separate business.”


“So, to summarize, the sector is becoming very exciting because it is in a state of change like it has never before seen.
Business leaders need to understand that it is not a “growth-as-usual” scenario, although there is potential for growth via innovations and in new geographies but it will be slower than before. I think there’s also more global scale for M&A and perhaps SCA is the one who will do more acquisitions. Although I typically don’t like acquisitions, because they are often hard to digest, this consolidation may be the best way for the tissue industry to move toward better profitability both in North America and globally”.



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