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By Jeremy Glaser | 02-01-2011 01:12 PM

Kimberly-Clark's Bonds Look Attractive

Despite the additional debt the firm is taking on to complete share buybacks, Kimberly-Clark's bonds still offer a compelling risk/return trade-off for investors.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm pleased today to be joined by Dave Sekera. He is a Senior Securities Analyst at Morningstar. We are going to take a closer look at a high credit quality company, Kimberly-Clark.

Dave, thanks for joining me today.

Dave Sekera: Thank you, Jeremy. Good to be here.

Glaser: So in the news recently Kimberly-Clark announced that they are going to have a pretty substantial stock buyback, which is something that is potentially a negative for bondholders. Can you talk to us a little bit about how, the Morningstar credit rating team approached this announcement and how you are thinking about it for the bondholders?

Sekera: Of course. Last week Kimberly-Clark announced their earnings for the year and as part of that earnings announcement, they did mention that they were going to do a $1.5 billion share buyback and that about half of that was going to be funded through new debt issuance, so about $750 million. This is actually really a good example of how Morningstar credit analysts and equity analysts work together in a partnership as we do our research on individual companies.

So the equity analysts and I, we were able to work together, we took a quick look at the financial model. We are able to create a pro forma financial model, which included the additional debt in there as well as the additional interest expense. And by doing that, we're able to quickly tell that we would not change our rating on the company. Currently, we rate the company an issuer rating of A+, which is one notch higher than both the rating agencies. So it's just a great example. You can show how we are proactive, taking a look at our model, proactive looking at our ratings and I think we are able to adjust to the differences in the market, more quickly than our competitors.

Glaser: Sounds like this isn't going to have a huge impact on bondholders then. What do you think about then the general credit quality of the company? Why is Kimberly-Clark rated so highly?

Sekera: Well, Kimberly-Clark itself is just a very good company. The company has probably top line growth in the mid-single digits. We are looking at cash flow growth, also in the mid-single digits. Taking a look at the credit metrics, the company is pro forma for the debt issue, still under 2 times leverage, probably is going to average about 1.5 times debt leverage over the next 5 years.

We're looking at low double-digit interest coverage over the next five years, that's probably going to average around 13 times and taking a look at our four pillars, which is how we base our credit metrics and base our credit rating, we're looking at a cash flow cushion of about 200% over the next five years. So this Company even with a relatively modest debt schedule or maturity schedule over the next couple of years is easily going to be able to fund their debts. So we really don't have any concerns about the company's liquidity over our forecast period.

Glaser: Kimberly-Clark obviously makes a lot of products like diapers and tissues and things that people really use on a day to day basis. Are you worried at all that in an extended economic downturn, the people could move to private label goods, or move away from some of these branded products.

Sekera: It's always a concern that we could see the consumer moving away to the private label, but we really have a substantial portfolio with a lot of brand equity. And as we've looked at the results over the past couple of years during this recession, we really haven't seen that kind of down trading that will cause us to reevaluate how we look at the credit rating of the company and the credit metrics that we believe are going to be a result of the amount of free cash flow this company can generate.

Glaser: Kimberly-Clark did just issue some new debt. What do you think about the pricing on that new issuance?

Sekera: So they did come with the bond issue at the end of last week. It's a $750 million deal broken up into two tranches. The first tranche was a ten-year deal. The second tranche was a 30 year deal. I think they priced $250 million of the ten year bonds at treasuries plus 60 which is about 4% yield; the 30 year bonds which I believe is $450 million, they priced that treasuries plus 80, which ended up being a 5.3% yield.

I think that they offer very good valuation here for individual investors. Taking a look at the company, I think there is pretty low headline risk here or event risk. Essentially when I am thinking about that, I am thinking of something that's going to impair the value or the market value to the bond holders. So, for example, we really don't believe there is going to be any LBO, leverage buyout risk here. So I am really looking at this as being just a good, attractive, solid value for investors, not something that I am going to expect the price to appreciate very quickly in the near term but something that's going to be a good defensive name and a credit spread, widening environment.

If we do have some sort of double dip recession, or spreads widen out just because the economy is not performing in expectations or inline with what the market believes right now. Now these markets will probably outperform to the downside just because I wouldn't expect the spreads to widen out nearly as much as you'd expect the rest of the credit market or the credit indices to widen out.

Glaser: Dave thanks so much for your thoughts today.

Sekera: You're welcome.

Glaser: From Morningstar, I am Jeremy Glaser.

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