Productivity & Beauty Hold the Key for P&G’s Turnaround

By Gayatri Sharma - August 30, 2012 | Tickers: CL, JNJ, K, KMB, PG | 0 Comments

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Procter & Gamble’s (NYSE: PG) stocks have underperformed both its peer group and the broader market year-to-date. Since the beginning of 2012, P&G's shares are essentially flat, as compared with gains of 12.2% in the S&P 500 and 3-15% gain in its peer group that includes Kimberly Clark Corporation (NYSE: KMB), Johnson & Johnson (NYSE: JNJ), and Colgate-Palmolive Co. (NYSE: CL). Despite this underperformance, the company is trading at a premium to many of its peers.

However, we believe P&G’s valuation is justified as the company pays an attractive dividend yielding 3.4% on a payout ratio of 69% and the company’s EPS growth next year is second only to Colgate-Palmolive with the highest valuation. Moreover, the company’s price-to-book ratio is much lower than that for its respective industry. Going forward, we anticipate productivity improvement and a turnaround in beauty & grooming businesses to drive better than expected results.

The company is at an important juncture today, as pressure on the management to execute well has never been higher given Ackman’s stake in the company. Though Procter & Gamble’s sales per employee are near industry highs, in this challenging global economic environment the company has struggled to grow sales and maintain its profitability. The management now seems focused on instilling a culture of productivity. We are encouraged by the various initiatives intended to create efficiencies in the non-value added parts of its business.

• The separation program is ahead of schedule, and by the time it’s done, it may reduce the employee count of the overhead by more than the targeted 10%.
• The demand forecasting group is expected to fall by 25%-30% from about 5,000 employees in 140 different locations. While the process will take 3 years, it has started to generate savings in the first 12 months itself.
• P&G has 20 plants under construction. As they are completed, it expects to staff them with no additional increase in the manufacturing headcount. This objective is integral to the goal that $6 billion of the projected savings of $10 billion will be sourced from cost of sales.

Going forward, we believe P&G’s turnaround is largely dependent on its beauty & grooming business. We believe the company has to sustainably fix its beauty business which represents over 50% of profits, has margins above the corporate average and operates in categories growing much faster than the company’s other divisions.  The beauty segment now represents a much bigger part of the company’s portfolio as compared to 2005.

Over the past 10 years, the company has spent close to $64 billion on acquisitions (mostly in the beauty business including Gillette). However, over the last four years P&G’s total sales were up 3.6% while total sales (excluding beauty) were up 3.7% indicating the Beauty division has had a minimal impact on sales growth over the last four years.

While there is a limited visibility on the beauty turnaround, we are impressed with the ongoing initiatives. We expect P&G’s recently appointed Global President of Beauty Care, Deb Henretta, to turn around this underperforming division. Deb Henretta has an impressive track record and has successfully executed a similar turnaround in P&G’s baby care division where she revived a struggling Pampers brand in the early 2000’s. She is focusing on North America, China, and cosmetics which account for 70% of Beauty sales and 80% of profits. She has also emphasized the need for more mid-tier offerings. P&G has higher demand elasticity to increased pricing than peers given its premium priced portfolio. Thus, the company’s increasing focus on mid-tier offerings is also a good move.

In addition, the company has already completed the sale of its Pringles business to Kellogg (NYSE: K). There is a possibility that the company may also consider other sales, such as its Lams pet food business and Duracell batteries that do not seem to fit well with the remaining non-durable household products, and health and beauty businesses. Thus, they are encouraging signs for the investors and we can finally see an appreciation in share price after a prolonged period of flattish trends. We recommend it a buy.

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