Is Kimberly-Clark Corp.'s Dividend as Safe as It Seems?

Kimberly-Clark is the name behind well-known personal care brands including Kleenex tissues and Huggies diapers. Combine that with an astonishing 42 years of dividend increases, and this stock seems like a safe dividend stalwart. Yet shares are trading near their 52-week high and the company's top-line growth has been mediocre. With that in mind, let's examine Kimberly-Clark's underlying business fundamentals to determine if its dividend is safe and if it is likely to go higher from here.

Start with the payout ratioAny analysis of a dividend stock should start with the payout ratio, especially when the topic is dividend safety. The payout ratio is the percentage of earnings a company pays out to shareholders in the form of dividends. Because investors chase high yields, some management teams will knowingly pay out more in dividends than they should. An investor's goal should be to find companies that can pay dividends while still investing in profitable business operations.

A general rule of thumb is to look for stocks with payouts below 60%, which is 10 percentage points higher than the S&P 500 average but still low enough to allow a mature business to avoid excessive debt in managing in dividend. Kimberly-Clark has a payout ratio under 60% -- 58.3%, according to S&P Capital IQ data -- and it has increased its dividend without issuing too much debt. The chart below shows that both the payout ratio and new debt issued have declined in recent years, which is a strong sign the dividend and business are healthy.

KMB Net Debt Issuance (Annual) data by YCharts.

A potential red flag?One peculiar thing about Kimberly-Clark is that earnings per share have risen much faster in recent years than have net income and operational cash flow, as shown below in this chart.

KMB Dividend data by YCharts.

The reason for this discrepancy might bethat Kimberly-Clark has retired a large number of its shares through its buyback program. This raises questions about the quality of earnings, the "E" in EPS. Ideally, we want profits to grow from business operations, not financial engineering, because they are more sustainable. This muddies Kimberly-Clark's impressive low payout ratio a bit, but its reasonable debt is still a very good sign.

Finally, we also would prefer that profits grow in the same range as the dividend. As shown in the chart above, the dividend has risen nearly twice as fast as net income over the past five years.

The takeaway: Today is safe, tomorrow is uncertainIn recent years, Kimberly-Clark has focused on returning value to shareholders. The recently announced $5 billion share buyback authorization,which follows 2011's $5 billion repurchase authorization, has done just that. Not only do these buybacks artificially boost EPS, they also retire dividend-paying shares so Kimberly-Clark can raise its yield while keeping its dividends paid reasonable. The company has cut costs, improved efficiency, and done nearly everything right, but sales might need to growto keep up the current pace of dividend growth.

Organic sales rose 4% last year, as well as last quarter, but the company has guided for full-year growth to come in lower than that. At some point Kimberly-Clark will need increased sales to drive earnings and dividend increases.

Management knows this. It has made smart moves to streamline the business, spinning off the health care division and exiting the struggling European diaper business to focus on core brands. This should allow Kimberly-Clark to invest more resources into its profitable operations, which should reap rewards.

With strong operations, a low payout ratio, reasonable levels of debt, and a high ratio of cash flow to capital expenditures (three to one), I believe Kimberly-Clark's dividend is very safe. The business is healthy, and I like this company a lot. But, at 20 times earnings, I'm waiting, either for a better price or signs that growth has improved, before buying shares.

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Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends Kimberly-Clark. 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.

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