Three Risks Procter & Gamble Should Worry About

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

One of the best places to find information is in a company's annual report to the Securities and Exchange Commission (SEC). These filings, known as a 10K, hold a plethora of important facts, figures, and statistics. They also contain a section aptly titled “Risk Factors.” It is a must read for an investor and, best of all, its usually in plain English. No need to get a law degree or a doctorate in some long dead language!

Dividend-focused investors, the investment style near and dear to my heart, should focus on company specific risks, as opposed to stock specific risks, since dividend investing is more like a marriage than a one-night stand. I've been reviewing Procter & Gamble (NYSE: PG) because its shares have come under pressure due to weak results in its emerging market push. My first step was to create a SWOT analysis, which you can read to get a better picture of the company, and below I've used the “Risk Factors” section to really spell out some of the key issues I think I need to watch.

Procter & Gamble is one of the world's largest branded consumer packaged goods providers. Founded more than one hundred years ago, it has used acquisitions and innovation to solidify its impressive list of brands in the world's markets. Today it reaches more than 180 countries with products ranging from batteries to laundry detergent and from perfume to razors. The company has 25 brands that have revenues of $1 billion or greater.

The risks I think are most salient are:

Mature products in largely mature markets
Procter & Gamble's portfolio is diverse, but filled with products in mature categories. In addition, the company's core brands are all category leaders, with material market share and impressive sales. Very often the categories in which it operates are growing slowly, if at all, leaving market share gains as the main means of increasing revenues. That is a challenge, since the company competes with large and equally well-financed companies. Losing market share may be a greater risk than not gaining market share, since just maintaining market can be hard when you are number one in a category.

Equally concerning is the fact that many of the company's brands are so large. While this helps ensure a steady revenue stream, it makes growth difficult. Indeed, it is much easier to grow sales of a $100 million brand than a $1 billion brand. Moreover, maintaining market share of such large brands often entails material marketing efforts and, thus, expenses.

These issues are compounded by the fact that there is only one real growth opportunity in the consumer product space and every company is focused on it. The growth of the middle class in emerging markets is not a new story. In fact, Procter & Gamble is a bit late to the game. Although it has the financial strength to compete effectively, the push into rapidly growing developing markets is a crowded trade.

Innovate or Die
Procter & Gamble's products are generally mature. However that doesn't mean it can stand idly by and collect sales. It must continually invest in its brands or risk them becoming stale or obsolete. Thus, research and development and marketing are vital to the company's long-term success. Its efforts here can vary from something as simple as changing the branding around a product (a new box color) to the creation of entirely new product categories. Historically, the company has done an excellent job on both the research and development and marketing fronts, but the importance of these expenditures can't be stressed enough. They are a part of the company's ongoing business expenses.

This is vital to recognize because many companies cut these expenses when they face adversity. In Procter & Gamble's case, there may be room for cutting, but cutting too deeply for too long could adversely impact the top and bottom line far into the future. It is harder to regain lost market share than to maintain the market share you already have since many customers are brand loyal. 

Consumer price sensitivity
The company's product portfolio skews heavily to the high end of the markets in which it competes. This emphasis on premium products can help keep margins wide, but it places Procter & Gamble at a disadvantage during times of economic weakness when customers may be forced to trade down to less expensive options. While those customers may, indeed, come back when times are flush again, the impact on sales during economic weakness could materially hamper the company's growth over shorter periods.

More important to the company's long-term growth, however, is price sensitivity in emerging markets. In these countries, a growing middle class will often have more money to spend but be unwilling to spend it on a premium laundry detergent or toothpaste because less expensive options are adequate.  For example, saving up for an aspirational purchase, such as buying a new car for the first time, may be more meaningful than buying Crest over a local brand of toothpaste that's been used for years. Thus, Procter & Gamble may be at something of a disadvantage in the very markets it hopes to tap for growth.

Interestingly, competition weaves its way through each of the above risks I highlighted. Indeed, competition in this industry can never be given too much attention. For example, Dow-30 component Johnson & Johnson (NYSE: JNJ) and Kimberly-Clark (NYSE: KMB) are two particularly large examples of the many well-heeled participants Procter & Gamble faces. Both JNJ and Kimberly have massive world-wide distribution machines and strong presences around the world.

In the case of Johnson & Johnson, it has the added benefit of its medical device and drug businesses, in addition to its branded consumer products arm, which might make it a better option for investors seeking broad diversification with just a handful of stocks. Kimberly-Clark, meanwhile, has faced headwinds similar to those Procter & Gamble is facing, but seems to be doing a better job at adapting. For example, Kimberly recently announced plans to move away from diaper markets in regions with low birth rates while maintaining its focus on emerging markets where birth rates remain elevated. Clearly, Procter & Gamble has to execute well on a virtually constant basis or it will quickly find itself at a disadvantage.

These are the risks I think are the biggest issues. Let me know what you think by commenting below.

ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend Johnson & Johnson, Kimberly-Clark, and The Procter & Gamble Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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