What’s Going On Under the Hood at Procter & Gamble?
After weeks of speculation, Procter & Gamble (NYSE:PG) announced on Wednesday that it will be reorganizing its global business units into four industry-based sectors. The transition is part of what amounts to a turnaround plan spearheaded by CEO A.G. Lafley, who returned to lead the company after a few years of underwhelming performance.
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. As P&G visualized it:
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 change, P&G’s growth strategy has 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) has 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.”
McDonald, the outgoing CEO, announced a $10 billion cost-reduction plan last year that Lafley intends to continue. 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 that assumes 5 percent organic growth (in line with the 2000-2009 average under Lafley, but ambitious compared to post-2009 growth). The cost-reduction plan included about 5,700 layoffs.
The program is expected to cost $3.5 billion over four years, with one year down. Restructuring charges took $0.03 per share out of third-quarter earnings (which almost seems marginal given the $0.08 per-share charge that was the result of currency devaluation in Brazil). That said, the company still beat its earnings outlook with core earnings of $0.99 per share, a 5 percent gain on the year, and credited the cost-reduction plan.
- Global Baby, Feminine, and Family Care — led by Group President Martin Riant
- Global Beauty — led by Group President Deborah A. Henretta
- Global Home Care — led by David S. Taylor
- Global Fabric and Home Care — led by Giovanni Ciserani
Alongside these changes, Dimitri Panayotopoulos, currently Vice Chairman, Global Business Units, has been elected Vice Chairman and Advisor to the Chairman and CEO.
The announcement of the changes didn’t move the stock much in early trading on Thursday, but activist investor Bill Ackman must be pretty pleased. Earlier in May at the Sohn Investment Conference, Ackman gave a presentation on why he thinks P&G is “vastly under-earning relative to its intrinsic earnings power.”
One of the reasons he laid out for why this is the case is an “inefficient organizational design” that is limiting the company’s execution and productivity. 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’s position is certainly bullish. The mean analyst price estimate is $84.78, a healthy if modest upside, but no where close to the $125 intrinsic value that Ackman sees in the stock by fiscal 2016. Ackman’s thesis is predicated on 5 percent organic earnings growth and a 24 percent EBIT margin. P&G is currently at 3 percent organic growth and a 19 percent EBIT margin.
It’s possible that the cost-savings plan and the organizational changes will bring about the positive earnings growth that Ackman suggests, which would be a welcome break to the company. The stock has underperformed Johnson & Johnson (NYSE:JNJ), a major competitor, this year to date, and is about neck and neck with Colgate-Palmolive (NYSE:CL). At the end of May, its year-to-date performance was lagging the industry by a fraction of a percent.
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