Procter & Gamble: There’s a Lot to Love Ahead of Earnings
Procter & Gamble (NYSE:PG) will report fiscal fourth quarter results on August 1, and all around expectations are fairly modest. Analysts are looking for revenue growth of 1.7 percent on the year to $20.55 billion, and earnings are expected to fall 5 cents on the year to 77 cents per share.
P&G is one of the oldest companies on the block, and has been a beacon of stability in the stock market ever since it was first traded on the NYSE in 1891. The company has increased its dividend at least once per year since 1957, and investors in the company currently enjoy a healthy 3 percent yield. P&G boasts an industry-leading operating margin of 20 percent (15.9 percent average among peers), and arguably the most recognizable portfolio of brands on the planet (P&G has 22 billion-dollar brands including Gillette, Tide, and Pampers).
But even the strongest businesses were shaken by the late-2000s financial crisis. P&G, which had met or exceeded organic revenues growth targets from 2005-2008, reported a rare miss in 2009, with just 2 percent growth on expectations for between 4 and 6 percent. That same year, legendary CEO A.G. Lafley retired, and P&G floundered, frequently lagging the S&P 500 and posting underwhelming growth.
But all that could be changing. At the end of May, P&G announced that Lafley, who led the company between 2000 and 2009, would be rejoining the company as Chairman, President, and CEO, replacing Bob McDonald, who held the position in the interim.
P&G experienced organic revenue growth of approximately 5 percent each year between 2001 and 2009. However, after 2009, the report cards that the company assigned to itself started getting blurrier and more ambiguous, as the global recession and economic downturn took its toll on the company. Organic sales growth declined from a 5 percent annual average under Lafley to just “1-2 percent above market growth rates” in 2010 and 2011. In 2012, P&G reported 3 percent annual growth, but the damage had been done.
By the end of 2012, shares had pretty much done nothing but trade sideways, and investors were beginning to put pressure on the company to shake things up.
Chief among the activist investors is Bill Ackman, who runs Pershing Square Capital Management. The $12 billion fund owns approximately 29 million shares of P&G, and Ackman laid out a thesis at the Sohn Investment Conference in May that touted the company as “one of the great businesses of the world.” Directly relevant to investors, Ackman argued that through a mix of management and structural changes, the company could increase earnings per share by 50 percent, and nearly double its stock price over the next few years.
Ackman argues that P&G is “vastly under-earning relative to its intrinsic earnings power” for a number of reasons. In his eyes, the company is suffering from a “bloated overhead cost structure,” some of which is due to the incomplete integration of Gillette in 2005. Manufacturing productivity also hasn’t been optimal over the past few years (but that may be more an issue with global demand than anything), and pricing in certain categories could use some editing (P&G owns many premium brands, which some consumers shied away from during and after recession).
What may be McDonald’s biggest mark on the company is a $10 billion cost-cutting program. The program is broken down into four broad parts. The lion’s share of the savings ($6 billion) will come from reductions in the cost of goods sold. The rest will be more or less split between overhead savings, marketing efficiencies, and operating leverage, which assumes 5 percent organic growth (in line with the 2000-2009 average under Lafley, but ambitious compared to post-2009 growth).
Here’s Ackman’s presentation from the May 2013 investor conference:
After weeks of speculation on the subject, P&G announced at the beginning of June that it will be reorganizing its global business units into four industry-based sectors. Historically, P&G broke its global business down into two major units: Beauty & Grooming, and Household Care. The global business units focused on consumers, brands, and competitors. The divisions were responsible for the innovation pipeline of the products under their umbrella, the profitability of those products, and ultimately the returns to shareholders from their businesses.
The structure was packed with advantages, and as a result, the company claimed more than $900 million in savings over the decade or so the company was organized this way. But as markets and economies changed, P&G’s growth strategy had to change as well. Underwhelming organic growth in the 2009 to 2012 period (between 3 and 4 percent, compared to a historic target of about 5 percent) compelled the company to undergo massive reorganization.
“This sector organization and leadership team will help us operate more effectively and efficiently to continue momentum behind P&G’s growth strategies,” said Lafley in a statement on the reorganization. “These changes build on the productivity and organization design work led by Bob McDonald, and will help us get closer to consumers and become more agile with customers.”
With all these changes in mind, P&G’s future is by no means bleak. Earnings have increased on a year-over-year basis over the last three quarters, even though revenue growth has been fairly soft and below expectations. Management set earnings guidance in the fourth quarter between 69 cents and 79 cents per share.
|2013 Q3||2013 Q2||2013 Q1||2012 Q4||2012 Q3|
|EPS Growth YoY||5.32%||10.91%||2.91%||-2.38%||-2.08|
|Revenue Growth YoY||2.00%||1.98%||-3.67%||-1.17%||1.51%|
However, P&G has led on the stock chart year-to-date.