MSF 506 – Financial Statement Analysis
Spring 2013
Outside Case - Kimberly-Clark and the Paper Industry
Your supervisor was very impressed with the work you performed on your first assignment (Midterm). He thinks that your level of analysis over the past few weeks has progressed to the degree that you are ready to take on a second industry (Company), pulp and paper (Kimberly-Clark Corporation). Included in Case 1 is the Kimberly-Clark Corporation 2012 Annual Report (see blackboard and company website). Your analysis for Case 1 is based on the completion of the sections below. Your written analysis must be typed and should be at minimum 8 to 10 pages in length, plus the inclusion of attachments. In order to obtain complete or partial credit on the sections below, you need to show all calculations (not just a final answer). Where applicable, you should state your assumptions. All analysis must be your own original work and must be submitted to your instructor by the assigned due date (your last class before finals week).
I.Assessment of Financial Distress
A.Calculate the Altman Z-score for 2012 and 2011. Note: Refer to the annual
report for stock prices. You must show all formulas and calculations.
2012 = 3.56
2011= 3.46
Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + T5.
T1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.
T2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.
T3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
T4 = Market Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.
T5 = Sales/ Total Assets. Standard measure for total asset turnover (varies greatly from industry to industry).
2012 / 2011WC/Assets / 0.025059 / 0.045734
RE/Assets / 0.443969 / 0.425541
EBIT/Assets / 0.135158 / 0.126052
MV of Equity/BV of liabilities / 2.341597 / 2.189065
Sales/Assets / 1.05988 / 1.076034
Altman Z-Score / 3.56 / 3.46
B. Comment on the significance of the Altman Z-scores calculated above.
The Altman Z –score tells about the ability of the company to meet its debt obligation. As in both years it is more than 2.99 therefore the company is not in the danger of bankruptcy, however, in the year 2012 it has improved further by 0.1 times as compared to 2011.
II.Analysis of Historical Operating Performance (GAAP Basis)
A. Perform a year-to-year trend analysis by computing the percentage change and dollar change between fiscal 2012 and fiscal 2011 for the following income statement items (use 2 decimal places to the right, i.e. 30.17%):
All in millions of dollars / 2012 / 2011 / Difference / % ChangeNet Sales / 21063 / 20846 / 217 / 1.04%
Gross Profit / 6749 / 6152 / 597 / 9.70%
Operating Income / 2686 / 2442 / 244 / 9.99%
EBIT / 2704 / 2460 / 244 / 9.92%
Interest Expense / 284 / 277 / 7 / 2.53%
Net Income / 1828 / 1684 / 144 / 8.55%
EBITDA / 3561 / 3551 / 10 / 0.28%
- Calculate the following profitability ratios for fiscal 2012 and fiscal 2011 (using 2 decimal places):
2012 / 2011
Gross Margin / 32.04% / 29.51%
Operating Margin / 12.75% / 11.71%
Interest Coverage / 952.11% / 888.09%
Net Margin / 8.68% / 8.08%
EBITDA Margin / 16.91% / 17.03%
-
C. Discuss in detail the change in Kimberly-Clark’s financial performance
Between fiscal 2012 and fiscal 2011 by discussing some of the information
derived in part A and B (key variances and margins) and your review of the
Management Discussion and Analysis and Footnotes in the annual report.
Your discussion should include comments pertaining to changes in
operating performance of the major business segments. Note: The
analysis should be comprehensive and must be your own original
thoughts.
The net income was increase by around 9% in the year 2012 as compared to 2011 due to increase in sales of around 1%. The increase in sales was due to innovative strategy by the company. In China, Russia and Latin America, the sales were 37% of total sales 2012 as compare to 36% in 2011, before considering the impact of foreign exchange fluctuation. In North America the sales were increases due to new product launch. It is expected that in future the results will be more lucrative.
The increase in gross profit and net income was around 10%, it shows that company has fixed cost in cost of goods sold and operating expenses, which does not change due to increase in sales. The increase in interest expenses was also around 3%. This shows that company has used almost the same amount of debt financing to run its operation.
III.Financial Position (GAAP Basis) and ROE (DuPont) Analysis
A. 1.Calculate Kimberly-Clark’ Return on Equity (ROE) for 2012 and 2011
using the 3-step DuPont model. Note: Show all formulas and calculations.
ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)
2012 / 2011Profit Margin / 8.68% / 8.08%
Assets Turnover / 1.06 / 1.08
Equity Multiplier / 3.76 / 3.50
ROE / 34.58% / 30.58%
- Discuss which factors (profitability, activity, solvency) are primarily
driving the change in ROE between fiscal 2012 and 2011.
All three factors are interrelated for the final result of ROE; any change in any factor will affect the final result. For 2012, the ROE is higher than 2011, due to higher profit margin and equity multiplier in 2012 as compared to 2011, despite the lower assets turnover.
B. Comment on Kimberly-Clark’s liquidity position, as of December 31, 2012.
Use liquidity ratios, available lines of credit, and the Company’s access to the
capital markets in your discussion.
2012 / 2011Current Assets / 6589 / 6283
Current Liabilities / 6091 / 5397
Current Ratio / 1.08 / 1.16
The above analysis shows that the current ratio has gone down by .08 in 2012, but still the company has $1.08 of current assets for each dollar of current liabilities, but it should not go further down below to 1, as it may create problem in the future.
The company has cash and equivalent balance of $1106 million and $764 million in the year 2012 and 2011. It shows that company has enough cash so it would not need the line of credit The company has excess cash surplus therefore the company has made short term investment in certificate of deposit and time deposits.
The market price of shares in 2011 was $73.56 and 84.43 in 2012, it shows the investor has confidence in company financial results and performance, therefore the company can ask for more money from investor in 2012 as compared to 2011.
C. 1. Comment on Kimberly-Clark’s capital structure as of December 31, 2012.
As part of your discussion, compare (calculate) the Company’s Total Debt-to-Total Capital ratio and Total Debt/EBITDA ratio for year-end 2012 and year-end 2011.
2012 / 2011Debt to Capital / 2.76 / 2.50
Debt to EBITDA / 4.10 / 3.90
The company gearing is more in the year 2012 as compared to 2011, as it has more debt to equity in 2012 by around .26 times as compared to 2011. The Debt to EBITDA is also more in 2012 by around 0.2 times as compared to 2011; it shows that the increase in debt has not made more changes in EBITDA in 2012 as compared to 2011.
- Calculate Kimberly-Clark’s enterprise value at December 31, 2012. Assume the Company’s debt is valued at 96. (Note: Find the common stock price in the annual report.) Discuss the significance of Kimberly-Clark’s enterprise value as part of your capital structure analysis.
In millions of $
Market Capitalization / 32868.6
add value of debt / 5937.6
add preferred stock / 549
add non controlling interest / 302
less cash and cash equivalent / -1106
Enterprise Value on Dec 2012 / 38551.2
It shows the worth of the company as on December 2012, according to book value the company worth is $5287 million while as per EV it is around 7 times more than the book value. More the value of common stock, the EV will be more the Debt financing does not increase the EV too much. Therefore the equity financing is more effective to increase the EV of the company.
D. 1.Calculate the average total life span of Kimberly-Clark’s property, plant
and equipment at December 31, 2012.
17457/828= 21 years.
- Calculate Kimberly-Clark’s average age of property, plant and equipment
at December 31, 2012.
9561/828 = 11.55 or 12 years.
- Comment on the outcome (meaning) of the ratios calculated above.
It shows that the life of property plant and equipment is 21 years and it has been used for around 12 years, it means that the company will need to replace them in next 9 years. For this purpose company will need a huge amount of investment in property plant and equipment after 9 years.
IV.3-Year Financial forecast - Management Case
Your supervisor has received the following forecast variables from
Kimberly-Clark management during a recent bank meeting he attended in Dallas:
Forecast Variables 2013, 2014, 2015
-Sales growth of 3.5%, 2.4%, and 3.3% projected for 2013, 2014, and 2015, respectively;
-Gross margin is forecasted to improve 0.21% each year, using the gross margin
in 2012 as the base year;
-Marketing, research and general expenses, as a percentage of net sales, for each
forecast period will be based on the 3-year historical average;
-Restructure and other unusual operating expense items are expected to be $5.5
million in 2013, $6.8 million in 2014, and $4.5 million in 2015 (all non-cash);
-Interest expense is projected to increase 0.7% each forecast period, using interest expense in 2012 as the base year;
-Other income (expense) is forecasted to be ($45.0 million) in 2013, $31.0 million
in 2014, and ($32.0 million) in 2015;
-Assume taxes on (pre-tax) earnings of 32.0% for all forecast periods;
-Assume no extraordinary items in the 3-year forecast;
-Ignore minority interests and net income from equity companies;
-The Company is projecting capital expenditures of $985.0 million in 2013,
$945.0 million in 2014, and $885.0 million in 2015. Assume maintenance
capital expenditures for each period is 40% of each of the above totals;
-Depreciation expense is forecasted to increase 3.2% each forecast period, using 2012 as the base year in computations (ignore for income statement);
-Management will begin paying dividends on common stock of 2.3% on net
earnings in each forecast period (if earnings are negative, no dividends will be
paid);
-Assume scheduled principal debt repayments (includes commercial paper) as
follows: 2013 - $756.0 million, 2014 - $523.0 million, 2015 - $343.0 million;
-Management projects lease rent expense of $174.0 million, $141.0 million and
$109.0 million in 2013, 2014, and 2015, respectively. (Note: These amounts are
included in marketing, research and general expense above; however, use
information for part C. below)
A. Using the Company’s forecast variables above, prepare a complete Income Statement Forecast for 2013, 2014, and 2015 (show all work).
Income Statement2013 / 2014 / 2015
Sales / 21800.21 / 22323.41 / 23060.08
Cost of Sales / 15037.03 / 15546.03 / 16268.47
Gross Profit / 6763.17 / 6777.38 / 6791.61
Marketing, Research and General / 4067.92 / 4165.55 / 4303.01
Other operating expenses / 5.50 / 6.80 / 4.50
Operating Income / 4062.42 / 4158.75 / 4298.51
Interest Expense / 289.01 / 291.03 / 293.07
Other Income / 45.00 / 31.00 / 32.00
Earnings before taxes / 3818.41 / 3898.72 / 4037.44
less Taxes / 1221.89 / 1247.59 / 1291.98
Net Income / 2596.52 / 2651.13 / 2745.46
See the attached excel sheet for working, the calculation will be shown when you will click on the respective cell.
B. Based on the above, prepare a Statement of Free Cash Flows for 2013, 2014, and 2015.
B / Free Cash FlowNet Income / 2596.52 / 2651.13 / 2745.46
Depreciation / 854.50 / 881.84 / 910.06
Operating Cash flow / 3451.01 / 3532.97 / 3655.52
less Capital Expenditure Maintenance / 394 / 378 / 354
Free Cash flow / 3057.01 / 3154.97 / 3301.52
C. Using the Fixed Charge Coverage ratio formula discussed in class, calculate Kimberly-Clark’s Fixed Charge Coverage (ratio) for 2013, 2014, and 2015
(show all work).
Fixed Charge Coverage ratio / 2013 / 2014 / 2015Lease Rental / 174 / 141 / 109
EBIT / 4062.42 / 4158.75 / 4298.51
Interest / 289.01 / 291.03 / 293.07
Fixed Charge Coverage ratio / 9.15 / 9.95 / 10.96
EBIT + Lease rental/Lease Rental + Interest
D. Comment on the overall trends from Management’s 3-Year Income Statement Forecast, the 3-Year Free Cash Flow Forecast and the 3-Year
Fixed Charge Coverage Forecast you prepared above.
The net income of the company is going to increase in next three years from $3818 million to $4037 million in 2015. The increase in net income will result in free cash flow of $3057 million in 2013 and will go to $3301 million in 2015. The increase in free cash flow may lead to increase in market price of shares, as the more dividends will be expected and can be paid due to free cash flow. This all results will be achieved due to expected growth in sales. The fixed coverage ratio is also increasing trend which shows that the company will have no problem in paying and meeting its obligation and commitments. It was around 9 times and went to 11 times in 2015.
V.3-Year Financial Forecast - (Student’s Name) Case
A. Based upon your independent review (analysis), briefly discuss the current
state of the personal care consumer products industry.
There are around 800 companies in the personal care consumer industry but 85% of total market share is controlled by top 50 US companies. There are various products are available such as hair care, cosmetics, toothpaste, shampoo, nail care, shaving cream and fragrances. The companies are concentrating in nature to make the product effective and harmless. The companies have to invest in research and development to make sure that the products are free from toxic chemical, which can be harmful. The women have largely contributed to the industry as the demand of women’s beauty product has gone up by 7 times as compare to other makeup products. The major success of the industry depends on the spending ability of the customer, innovation in the products, advertisement approach and change in lifestyle of a particular group of people.
Given your analysis of Kimberly-Clark’s historical financial performance (sections II and III above), your projected outlook of the paper industry, and the additional assumption information below, prepare a forecast of the
following income statement variables for 2013, 2014, and 2015 using the required format provided below:
2013 / 2014 / 2015Sales Growth / 0.50% / -2.00% / 2.00%
Gross Margin / 30.00% / 28.00% / 30.00%
Marketing, Research and General Expense (% of sales) / 20.00% / 20.00% / 20.00%
Interest Expense (% of sales) / 1.50% / 2.00% / 2.00%
Note: .
Additional Assumptions For Student’s Case
- economic recession in 2014 with economic recovery by 2015
- Kimberly-Clark is the low-cost producer of paper products
- no major acquisitions or divestitures planned in the projected 3-year
horizon
- slight loss of market share due to entry of another small competitor in 2014
- an increase in raw material prices during 2013 and 2014
- the company will have higher average usage of the revolving credit facility during 2014 and
2015 to fund the increased raw material costs.
C. Using the information you provided in V.B. above and assuming all other income statement variables are the same as the Management Case Forecast (Section IV – other income (expense), restructure and other unusual items;
Interest expense; and income tax expense percentage;), prepare a second
Income Statement Forecast for 2013, 2014, and 2015.
Part V / Income StatementC / 2013 / 2014 / 2015
Sales / 21168.32 / 20744.95 / 21159.85
Cost of Sales / 14817.82 / 14936.36 / 14811.89
Gross Profit / 6350.49 / 5808.59 / 6347.95
Marketing, Research and General / 4233.66 / 4148.99 / 4231.97
Other operating expenses / 5.50 / 6.80 / 4.50
Operating Income / 4228.16 / 4142.19 / 4227.47
Interest Expense / 317.52 / 414.90 / 423.20
Other Income / 45.00 / 31.00 / 32.00
Earnings before taxes / 3955.64 / 3758.29 / 3836.27
less Taxes / 1265.80 / 1202.65 / 1227.61
Net Income / 2689.83 / 2555.64 / 2608.67
D. Based on the above, prepare a Statement of Free Cash Flows for 2013,
2014, and 2015. Assume all free cash flow variables are the same as the
Management Case, with the exception of dividends. You may adjust “the
dividends on common stock, as a percentage of net earnings” assumption as
you deem appropriate.
D / Free Cash FlowNet Income / 2689.83 / 2555.64 / 2608.67
Depreciation / 854.50 / 881.84 / 910.06
Operating Cash flow / 3544.33 / 3437.48 / 3518.72
less Capital Expenditure Maintenance / 394 / 378 / 354
Free Cash flow / 3150.33 / 3059.48 / 3164.72
E. Comment on your rationale for the selection of variables above and on the overall financial performance trends from your 3-Year Kimberly-Clark
Income Statement and Free Cash Flow Forecasts.
Sales growth is expected to be 50% of 2012 growth due to entrance of new competitors, in 2014 it went down by 2% due to recession and again it recovered by 2% in 2015 due to economic recovery.
The gross margin was lower than 2012 as the material price is going to increase, moreover in 2014, the gross margin further went down due to fixed cost which was not covered by decline in sales. However in 2015 it was again 30% of sales.
Marketing, research and admin expenses were also increased due to inflationary impact in 2013, 2014 and 2015.
The interest expense in 2013 were almost the same in terms of percentage as in 2012, but in 2014 and in 2015 went up to 2%
Overall performance of the company seems to be satisfactory, keeping in view the future recession and competition. The company will be generating net income and free cash flow in all three years, only with change in the trend; in 2014 both net income and free cash flow would go down but again in 2015 it will go up, it shows that the company has enough potential to combat the market factors.
VI. Adjusted Financial Analysis (Non-GAAP)
A. Prepare an entire adjusted income statement for fiscal 2012 and fiscal 2011
based on your normalization of the Company’s earnings. (Assume an adjusted
tax rate of 32.0% on pre-tax earnings for both years.)
Adjusted Income StatementYear Ended December 31 / 2012 / 2013
(Millions of dollars, except per share amounts)
Net Sales / 21063 / 20846
Cost of products sold / 14284 / 14724
Gross Profit / 6779 / 6122
Marketing, research and general expenses / 3949 / 3671
Other (income) and expense, net / -6 / -51
Operating Profit / 2836 / 2502
Interest income / 18 / 18
Interest expense / -284 / -277
Income Before Income Taxes and Equity Interests / 2570 / 2243
Provision for income taxes / 822.4 / 717.76
Income Before Equity Interests / 1747.6 / 1525.24
Share of net income of equity companies / 176 / 161
Net Income / 1923.6 / 1686.24
Net income attributable to noncontrolling interests / -78 / -93
Net Income Attributable to Kimberly-Clark Corporation / 1845.6 / 1593.24
B. List and explain in detail your rationalization for excluding (including) individual items on (not on) the GAAP income statement for each year to
arrive at 2011 and 2012 normalized earnings. (Note: use footnotes as a
primary resource)
The ending inventory in 2011 was overstated by $30 million due to costing error in finished goods item.The ending inventory error will be adjusted in 2012 as opening inventory, thus the cost of goods sold will
increase in 2011 and will decrease in 2012 by $30 million.
The advertising expenses for 2012 and 2011 were incurred for specialcampaign, which was shown as expenses
but the result will appear in 2013 and onwards amounted to $120 million and $90 million in 2012 and 2011
Respectively.
Therefore these extra ordinary advertising expenses have been reduced in expenses of both years.
C.1 Calculate the adjusted return on assets (ROA) and adjusted return on
equity (ROE) for 2012 (only) based on normalized earnings. (Note: You