Procter & Gamble – Price Increases and Cost-Cutting Strategies

Procter & Gamble is focused on providing branded consumer packaged goods to consumers around the world. The company was founded by William Procter and James Gamble in 1837 and is headquartered in Cincinnati, OH. Procter & Gamble sells its products in more than 180 countries and territories.  Procter & Gamble reaches its customers through mass merchandisers, grocery stores, membership club stores, drug stores, department stores, distributors, wholesalers, baby stores, specialty beauty stores, e-commerce, high-frequency stores, and pharmacies.

As of June 30, 2017, the Company has five reportable segments under U.S. GAAP: Beauty; Grooming; Health Care; Fabric & Home Care; and Baby, Feminine & Family Care. The beauty segment consists of hair, skin and personal care. The grooming segment includes shaving care products and appliances. The health care segment contains oral, and personal health care products. The fabric and home care segments offer detergents, laundry additives, air and dish care. The baby, feminine and family care segment involves diapers, baby wipes, feminine care, paper towels, tissues, and toilet paper.

Overview

According to the company’s annual report in 2017, Procter & Gamble is the global market leader in the beauty segment. Procter & Gamble’s retail hair care global market share is over 20%. The company’s Gillette brand has nearly 65% market share in global blades and razors market in grooming segment. In a competitive oral care market, Procter & Gamble’s global market share is approximately 20%. The brands of Tide, Ariel, and Downy carry Procter & Gamble to the leading global position of fabric care market, with more than 25% market share. In both baby and feminine care segments, the company has over 25% global market share each.

Procter & Gamble will likely achieve to increase prices, but the surge may not be sustainable. As the company’s finance chief, Mr. Moeller, states, the price increase may create a reaction in the industry, and competitors may respond with promotional activity. Mr. Moeller also said that pricing would introduce uncertainty and would impact demand and volume. There is uncertainty whether Procter & Gamble will need future promotion activities to regain market share.

P&G completed its plan to streamline product portfolio by divesting, discontinuing, or consolidating about 100 non-strategic brands. Procter & Gamble currently has 65 brands, which provides benefits of high-return opportunities with increased focus.

After one of the most massive proxy fights in the US, Nelson Peltz campaigned for the board seat in 2017 and criticized the P&G’s “suffocating bureaucracy”, argued that the company did not have a senior executive in an operating position who had any pronounced outside experience. Mr. Peltz also discussed that Procter & Gamble needs to reduce its segments to three from five. P&G added Mr. Peltz to the board to avoid a destructive and costly legal battle.

Mr. Moeller also said that pricing would introduce uncertainty and would impact demand and volume. Procter & Gamble currently has 65 brands, which provides benefits of high-return opportunities with increased focus.

Investment Characteristics

In the fiscal year 2018, P&G’s organic sales growth is increased by 1%, and its organic volume growth is 2%. In the fourth quarter of 2018, the beauty segment organic sales are up 7%. In the same period, the grooming segment organic sales declined by 3% due to declines in developed markets sales and stable developing markets revenues. The health care segment and fabric & home care organic sales are surged by 1% and 2%, respectively. The baby, feminine, and family care segment organic sales are dropped by 2% in the last quarter of the fiscal year 2018 due to competition and innovation across the industry.

P&G’s USD 10 billion cost-cutting initiative in 2017 includes reducing overhead costs, lowering material costs, and accelerating manufacturing and marketing productivity.

While analyzing the company’s annual revenue stream, we noticed that the revenue declined by more than 7% in 2014. After 2014, Procter & Gamble’s average annual revenue decline is more than 3% through 2017. The revenue trend during the 2014-2017 period supports the company’s divestiture and consolidation strategies. However, after completion of brand reduction in the fiscal year 2018, P&G’s revenue is up 2.7%. The dominant segments supporting a surge in sales are beauty, health care, and fabric, and home care.

In the current period, there is a gross profit margin deterioration. The gross margin contradicts the previous four-year trend. The current transportation costs due to a shortage of truck drivers, competitive pricing, energy expenses, foreign exchange effects in developing countries offset the positive impact of revenue surge. The company is also facing consumer behavior changes and niche brand popularity.

Procter & Gambles’ net income from continuing operations reduced by more than USD 325 million from a year ago.

The current transportation costs due to a shortage of truck drivers, competitive pricing, energy expenses, foreign exchange effects in developing countries offset the positive impact of revenue surge.

Valuation

Our fair value estimate for Procter & Gamble is USD 94 per share. We estimate the company’s enterprise-value-to-EBIT ratio of 21.65. Also, an estimated enterprise-value-to-sales ratio is 7.6 in our analysis. The competition in the consumer care industry and price increases will deteriorate P&G’s short-term growth estimates. However, we assess the long-term growth rate in 2-3.5% range. P&G’s competitors increase their revenue by approximately 2-3% range in the consumer care industry. The company’s integration of activist investors into its board and adapting core business approach may provide small competitive volume and price increase. We consider slight edge performance is realistic in our estimates, mainly due to revisions in marketing and manufacturing strategies. The company has leading market shares in each segment and has growth potential in European-developed markets. Also, the company has higher potential in developing markets even with stable growth in these regions. We consider Chinese market growth potential needs to be assessed and increasing disposable income and young consumers create brand commitment opportunities. In addition to reducing brands for improving focus, Procter and Gamble started an additional USD 10 billion multi-year productivity and cost-saving plan. The company plans to accelerate productivity and cost savings with reasonable levels of manufacturing and marketing costs. These cost-saving efforts support our EBITDA margin estimates of 23%-25% range.

Risks to consider

Consumers tend to spend less in the current economic environment. Increasing material and logistics costs pressure the company to increase its price levels. However, promotional activities increase consumer expectations of lower prices in the consumer products industry. P&G management believes that the current upside trend in the economy may increase consumer spending through high-priced brands. The management has a very contentious decision. The company may lose the market share because its competitors may not follow P&G’s price surge strategy.

According to the company’s annual report, P&G’s 58% of its sales originated outside the US, with operations in approximately 70 countries and products sold in more than 180 countries and territories worldwide. Fluctuations in exchange rates for foreign currencies may impact negatively on its financial statements. The company’s non-US sales may increase supply costs and reduce profitability as P&G’s manufacturing and selling locations are sometimes different, which may adversely impact its financial condition.

The consumer products industry is highly competitive. P&G competes against a wide variety of global and niche local competitors. Most investors tend to complain about the lack of sales increases. The quality and safety of its products are vital to its business. Many of the brands have worldwide recognition, and P&G’s financial success is directly dependent on the success of its brands. The company’s grooming and baby, feminine & family care sectors especially face declining revenues. P&G revises its marketing strategy and invests in products for a new generation, and launching subscription-based models. As e-commerce companies like Dollar Shave Club and Harry’s press for low prices and thin margins.

Promotional activities increase consumer expectations of lower prices in the consumer products industry. Fluctuations in exchange rates for foreign currencies may impact negatively on its financial statements. E-commerce companies like Dollar Shave Club and Harry’s press for low prices and thin margins.

Other considerations

ctivist investor Nelson Peltz managed a campaign in February 2017 by announcing a USD 3.5 billion stake or around 1% of shares outstanding, his substantial investment. Mr. Peltz wants to simplify P&G’s segments, ranging from grooming, home care, and family care. After Mr. Peltz’s arrival, P&G has announced the acquisition of Merck’s consumer health business for about EUR 3.4 billion, extending its portfolio of a health-care segment. David Taylor, the CEO, claimed that recent discussions with Mr. Peltz have been helpful. While Mr. Peltz has not overly influenced the board yet, his alignment could optimistically encourage the company to continue its strategic goals. Procter & Gamble has declining revenues in grooming, indicating less than 10% of sales. However, the company focusing on fewer brands, reducing brand complexities in its segments, and adjusting its investments through current trends.

Investors’ expectations are sales growth. The company needs to restore its razor unit and focus on locations not generating revenues, such as China. To reduce the impact of rising costs, P&G reduced the jobs force by 9.5% in 2017 and consolidated its advertisement costs with few agencies. Mr. Moeller, finance chief, said that trade tariffs and geopolitical tensions, alongside competitive price and currency pressures, could continue to weigh on the group in the year ahead.

Conclusion

P&G and its peers analysis as of August 2018
Source: tradingview.com

Procter & Gamble has an unbeatable dividend payment history. The company has been paying a dividend for 128 consecutive years since its incorporation in 1890. P&G has a lower price-to-earnings ratio compared to its peers. These characteristics indicate that the company is categorized as a dividend-paying large-cap value stock. P&G stock peaked in December 2017 with more than USD 93 per share after activist investor Mr. Peltz secured its board to avoid an expensive proxy battle. However, its stock price declined to USD 72 per share after P&G agreed to buy the consumer health business of Merck for EUR 3.4 billion. Investors impatiently wait for revenue increases from the company. We think that especially inclusion of activist investors on its board, P&G will reduce the complexity of its operations and improve its operations with cost-cutting strategies.

Disclosure: I do not have any of the securities mentioned above. This article expresses my own views, and I wrote the article by myself. I am not receiving compensation for it. I have no business relationship with any company whose security is mentioned in this article.

Image Source: Procter & Gamble Website

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Covers investment, financial analysis and related financial market issues for BrightHedge. He has extensive experience in portfolio management, business consulting, risk management, and accounting areas.

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The investment information, comments and recommendations contained herein are not subject to investment advice. The comments and recommendations contained herein are based on personal views. These views may not fit your financial situation and your risk and return preferences. For this reason, based only on the information contained herein, investment decisions may not have the appropriate outcome.