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Investment Overview for Procter & Gamble (NYSE:PG)
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P&G's Fabric & Home Care EBITDA Margin: EBITDA margins for the Fabric Care & Home Care division improved from 23% in 2008 to 25.7% in 2009 due to lower commodity costs and manufacturing cost savings. It declined to 22.6% in 2010 and 20.4% in 2011 mainly due to the higher commodity cost environment and an unfavorable product mix resulting from the disproportionate growth of developing regions and mid-tier products, along with higher SG&A costs. Going forward, we expect P&G to witness continued decline in margins in the short term, with potential recoveries in the long-term. There could be a 5% upside to our price forecast if the margins reach the 2009 levels of 25-26% by the end of the forecast period due to cost cuts and lower input costs.
P&G's Beauty EBITDA Margin: Beauty EBITDA Margins improved from 24.7% in 2008 to 25% in 2009 due to lower commodity costs, cost cuts, as well as a favorable product mix and exchange rates. It declined to 23.8% in 2010 and 21.6% in 2011 mainly due to the higher commodity cost environment. Going forward, we expect P&G to witness continued decline in margins in the short term, with potential recoveries in the long-term. There could be a 5% upside to our price forecast if margins reach the 2009 levels of 25% by the end of our forecast period due to cost cutting and lower input costs.
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Procter & Gamble (P&G) is a global company with operations in over 180 countries. P&G manufactures and sells consumer goods across multiple product segments that are part of the larger beauty, grooming, health care, snacks, pet care, household care and baby care reportable business segments. As of 2011, 24 of P&G's brands have more than a billion dollars in net annual sales.
P&G sells its products directly to mass merchandisers, grocery stores, membership club stores, drug stores and high-frequency stores. Sales to Wal-Mart stores and its affiliates represent approximately 15% of P&G's total revenues.
P&G has built significant scale by acquiring popular brands such as Gillette, Duracell, Wella Professional, Iams and Ambi Pur. In July 2011, P&G entered into a partnership with Teva Pharmaceuticals in consumer health care to bring together both companies' existing OTC medicine businesses and complementary capabilities. It has also decided to divest its Pringles snacks business to the Kellogg Company for $2.7 billion in cash. The transaction that is expected to be completed by mid-2012, marks the final part of P&G’s exit from the food business to focus on the high-growth, high-margin personal care brands.
P&G's easy access to capital resources offer it capabilities to invest heavily on research and development (R&D) programs, brand building, marketing campaigns, direct-to-consumer advertising and market research. P&G has a presence internationally with an established network of retail channels that provide it a route to leverage high growth in emerging markets by easily reaching the end consumer.
The North American markets continues to contribute about 40% to the net sales of Procter & Gamble followed by developing markets (32% of net sales) and Western Europe (21% of net sales). Sales from developing markets are increasing as P&G is rapidly expanding in these markets. P&G has been aggressively pursuing expansion and deeper market penetration in the emerging markets with significant investments. With a target to acquire one billion new customers by 2015, it will add 20 new manufacturing units in Brazil, China and Eastern Europe over the next few years. This growth would include a $1 billion investment in China to expand operations.
In February 2012, P&G announced plans to save $10 billion in costs by 2016, which would include a $1 billion reduction in marketing costs and $3 billion in overhead expenses. It plans to eliminate more than 4,000 jobs and rationalize its massive marketing budget in an effort to streamline its relatively bloated cost structure that has so far weighed on its profits. It is likely to execute 1,600 job losses in the current fiscal year. These cost cuts will significantly help the company improve its margins over the next few years.
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We believe 1) Detergents (Tide, Ariel) & Household Cleaning (Down & Cascade), and 2) Gillette (Mach3, Fusion, Venus) & Braun are the most valuable segments for P&G for the following reasons:
Detergents market share is smaller but the market size is twice that of grooming products
Procter & Gamble leads the $65 billion global detergents market (including laundry detergents like Tide & Ariel) with close to a 20% market share, making its products easily the most popular and most widely available laundry detergents globally, especially in the US. The Tide, Downy & Gain brands have a near monopoly in the US detergents market with close to a 60% share.
In comparison, P&G’s share of the $16 billion global grooming market (including Gillette & Braun brands) is 50% as of 2011. Gillette has gained substantial brand equity from years of heavy investment into R&D and advertising campaigns such as the title sponsorship of football world cup from 1960 to 2006. A high market share, coupled with brand recognition among consumers worldwide, offers Gillette an opportunity to expand its other shaving and male grooming products and increase its overall market share of the grooming market in the future.
Higher profit margins for grooming (Gillette & Braun) brands higher compared to Beauty, Fabric & Home Care, Baby & Family Care
In 2011, Gillette (Mach3, Fusion, Venus) & Braun had EBITDA margins of close to 30%. This is higher than the 22% margins generated for P&G Laundry, Beauty, and Baby & Family Care brands, which generate more than 70% of the company's sales. This is driven in part by low manufacturing cost of razors and blades sold.
P&G's razors & blades product segment has a market share of 40% in the overall grooming market and is also the fastest growing segment with an annualized growth rate of 8% since 2001. P&G's global male blades and razors market share is approximately 70%. Trefis believes that the increasing demand from emerging markets, increasing awareness for health and wellness among male consumers, and an increasing number of advanced products are expected to bolster future growth of manual razors and blades. Gillette which has the highest market share will accrue a large portion of this incremental growth in the grooming market.
The presence of low-cost competition from generics gives Gillette an incentive to innovate and introduce better products such as Fusion (a 6 blade razor). This gives it an opportunity to charge higher prices by expanding into the premium product segment, thereby increasing its revenues and operating margins in the future.
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Target to cut $10 billion in costs by 2012
In February 2012, P&G announced plans to save $10 billion in costs by 2016, which would include a $1 billion reduction in marketing costs and $3 billion in overhead expenses. It plans to eliminate more than 4,000 jobs and rationalize its massive marketing budget in an effort to streamline its relatively bloated cost structure that has so far weighed on its profits. It is likely to cut 1,600 jobs in the current fiscal year. These cost cuts, although very ambitious, should significantly help the company improve its margins over the next few years.
Measured expansion in emerging markets to focus on regaining market share in developed markets
In light of declined earnings and recent market share losses in its core markets, P&G has decided to slow down its expansion across the emerging markets in order to refocus resources on stabilizing its market share growth and operating margin performance in its developed markets. Even though expanding the geographical and product footprint across emerging markets is critical for the growth of consumer giants, a high commodity cost environment, expansion costs and supply chain shortages made P&G's fast-paced expansion more difficult and costly than previously expected. Competitors like Unilever fared better amid the same challenging market conditions.
Emerging markets currently account for about 37% of P&G's annual sales, up from 20% in 2000. P&G had set a target of acquiring one billion new customers by 2014-15 through expansion to new markets and plans to add around 20 manufacturing facilities in emerging markets such as Brazil, China and Eastern Europe by 2015. In the current scenario, it is likely to proceed with a more measured approach. It has now decided to focus on the health and competitiveness of its core and most profitable businesses, starting with its top 40 country-product categories (out of a total 1,000 categories) that account for more than half of the company's sales. The next step is to strengthen its position in its 10 largest emerging markets, including China, India, Indonesia, Brazil and Russia.
P&G will however not exit from any country-product category already entered. In addition, any further expansions are likely to be more measured, with a focus on 'self-funded' expansion.
Nonetheless, as developed markets near saturation, emerging markets continue to grow in the high single digits, compared to low growth in developed markets. This makes them attractive for sales volume growth and market share expansion. New innovations and product launches with broad-based marketing support can quickly create significant opportunity in emerging markets. For instance, China's diaper market for Pampers has grown from $200 million to $2.8 billion (14x) within the last ten years. Even today, the average consumer changes a diaper less than once per day in China and India, compared to twice per day in Brazil and four times per day in the U.S.
P&G estimates that it generates annual sales of about $96 per person in the U.S, $20 per person in Mexico, $4 per person in China and just $1 per person in India, Sub-Sahara and Indonesia. Increasing per capita spend in these four big markets to the level of Mexico would add more than $60 billion to annual sales. A BCG study estimates China is likely to add about 250 million consumers to its middle and affluent class over the next decade, roughly the same as in the U.S.
Huge R&D budget and product innovation
P&G annually invests about $2 billion in research & development, 60% more than its closest competitor, Unilever and more than most of its competitors combined. It helps P&G launch improved and innovative products at regular intervals to maintain, as well as expand its market share. The latest examples of innovation by P&G include Gillette Fusion ProGlide, Crest 3D White, Laundry additives and the Pampers thinness and absorbency upgrade. Trefis believes that innovation, particularly in the premium categories, is the key to driving profitability as P&G already has significant scale and a high level of concentration in developed markets like the US, Western Europe and Japan.
Sustained marketing efforts to defend market share
P&G continues to invest heavily on advertising and promotion of its brands. Trefis believes P&G's advertising and marketing capabilities are important growth drivers for sales as they help maintain brand novelty and defend the high market share position that P&G enjoys.
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