Three Reasons to Sell P&G

By Ashish Sharma - May 15, 2012 | Tickers: CHD, CL, PG, CLX, UL | 0 Comments

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Procter & Gamble (NYSE: PG) is the largest consumer products company in the world with total sales exceeding $81 billion in FY11. The stock has underperformed the broader markets and its peer group year to date in 2012. I expect this underperformance to continue given the company’s slow organic growth rate, declining market share, and an over optimistic cost-cutting plan on which the company is likely to disappoint. Here is a look at some of these points in detail.

Low Organic Sales Growth and Declining Market Share

Procter & Gamble’s recent Q3FY12 results were disappointing. Its organic growth lagged its peers and it was unable to register any volume growth. The following table compares P&G’s organic sales in the last quarter versus its peers.

Table1: PG Organic Sales growth comparison (last quarter)

It is interesting to note that while each of the peer group companies (except CHD) was able to successfully execute price increase and simultaneously increase volumes, P&G was the only company unable to register any volume growth. Further, if we take into account Organic Growth from volume, pricing and mix, P&G reported lowest growth rate of just 3%. I believe P&G’s premium pricing position versus its peers make it more vulnerable to weaker macros.

Now some of you may argue that each of the above companies has different geography and category exposure, so the above Volume/Pricing/Organic Growth comparison may not give the correct picture. So, here is another thing to consider. Last year, in the same quarter P&G was gaining or maintaining market share in categories representing ~75% of its sales. In contrast, in Q3FY12 P&G was able to maintain or gain share in categories representing only 45% of its sales. This further supports that P&G is lagging its peers and losing its market share.

Over Optimism on Cost-Cutting/Restructuring Plan

After top line trends the second most important driver for P&G’s stock is management’s ability to cut costs. During its Feb’12 conference call at CAGNY, P&G announced an ambitious $10 billion long-term (FY2016) cost-savings program. The key areas for cost cutting outlined by the company are summarized in the table below.

Table2: P&G’s $10 billion cost-cutting plan

Source: Company reports

Although a lot of analysts are now building this cost-cutting plan in their projections, I am not too optimistic on it. The first reason for my skepticism is Procter & Gamble’s poor track record in terms of its actual performance versus its guidance in the recent past. PG has already reduced its EPS guidance this year by ~9% vs. the midpoint of its original goal. Consensus forecast for P&G has seen steady decline over the past couple of years. Clearly, it is difficult to trust management’s word in the current situation.

Secondly, out of $10 billion cost-cutting goal, $2 billion is coming from overhead leverage. This isn’t essentially cost cutting. Almost all consumer companies see operating leverage with increasing revenues. So, this is not something specific to P&G and its $10 billion cost-cutting plan is in effect only $8 billion cost-cutting plan.

Also, the company’s plan is more COGS based ($6 billion) than SG&A based ($1 billion ex. Operating leverage). Clearly, SG&A is something where a company has more control as compared to COGS, which depends on a lot of external factors (like inflation, etc.). So, it does raise doubts on whether P&G will be able to achieve its goals. Further, if we look at P&G’s gross margins they are more in line with its peers and there is not much scope for reduction. On the other hand, P&G’s SG&A expenses are well above the group average (see table 3). Hence, I would have been more optimistic if P&G would have given more weight to cutting its SG&A costs.

Table 3: Procter & Gamble’s margins versus Colgate and Church & Dwight

Note: Colgate’s adjusted gross margin data includes its shipping and handling cost, which it reports in SG&A. CHD’s adjusted gross margin data is for its consumer business only (excludes specialty business) and is for FY10, while all other data’s are for FY11. Source: Company reports

Finally, even if P&G is able to reduce some of the costs, its benefit is unlikely to flow to the share holders in the near term given the company’s poor top-line performance. These savings will likely be reinvested in the business to prevent further market share losses and hence there is little to be excited about these cost-saving measures.   

Valuations

P&G is currently trading at 19.49x PE (ttm), which is a premium to Unilever (17.71x PE) and Clorox (17.15x PE) and in line with Colgate (19.76x PE). I believe the company should be trading at a significant discount to its peer group given its disappointing topline sales performance and market share losses. Hence, I recommend a sell on the stock.

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