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Investment Overview for Procter & Gamble (NYSE:PG)
P&G's Fabric Care and Home Care EBITDA Margin: EBITDA margin for the Fabric Care and Home Care division improved from 24% in 2008 to 27% in 2009 due to lower commodity costs and manufacturing cost savings. It gradually declined to 20% in 2014 due to a combination of commodity cost inflation, unfavorable product mix resulting from the disproportionate growth of developing regions and mid-tier products, and foreign currency headwinds. It improved significantly in 2015 to 23% on the back of strong cost savings. Going forward, we expect P&G to witness an improvement in margins through its ambitious cost savings program and heavy focus on productivity improvements. Divestment of under-performing brands will also provide a boost to margins. There could be a 10% downside to our price forecast if P&G's Fabric Care and Home Care EBITDA margins falls to 15% by the end of our forecast period.
P&G's Beauty EBITDA Margin: p&G's Beauty EBITDA Margins improved marginally in 2009 compared to the previous year due to lower commodity costs, cost cuts, as well as a favorable product mix and exchange rates. It gradually declined to 19.7% by 2013 mainly due to the higher commodity cost environment. EBITDA Margins improved to 24% by 2015 due to substantial cost savings and divestment of underperforming brands. Going forward, we forecast P&G's Beauty EBITDA margins to improve steadily to over 28% by 2022. There could be a downside of about 5% to our valuation for the company if the margins remain at the current level.
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, household care and baby care reportable business segments. At the end of fiscal 2014, 23 of P&G's brands reported more than a billion dollars in net annual sales.
P&G has built significant scale by acquiring popular brands such as Gillette, Wella Professional, Iams and Ambi Pur. 2014 was a watershed moment in the global behemoth's history as it switched from unchecked expansion to a brand consolidation strategy. In 2015, P&G announced the disposal of a large number of brands as part of its brand consolidation program, under which it would divest 100 under-performing and non-core brands. Following the completion of the program, the company would retain just 60 core brands which are leaders in their respective categories. As part of the program, P&G sold the Duracell battery business and nearly 50 beauty brands in 2015.
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 an international presence 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 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 its operations in these markets. P&G has been aggressively pursuing expansion and deeper market penetration in the emerging markets with significant investments.
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 size is twice that of grooming products
Procter & Gamble leads the $80 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 account for close to a 60% of the U.S. detergent market.
In comparison, P&G’s share of the $18 billion global grooming market (including Gillette & Braun brands) is less than 40%. Gillette has gained substantial brand equity from years of heavy investment into R&D and advertising campaigns. 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 compared to Beauty, Fabric & Home Care, Baby & Family Care
Gillette (Mach3, Fusion, Venus) & Braun have EBITDA margins of over 35%. This is higher than the 23% 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 50% in the overall grooming market. 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.
In August 2014, P&G announced its plan to trim its portfolio of nearly 200 brands to just 70-80 core brands. These top 70-80 brands account for over 90% of P&G's revenues and 95% of net profit. The strategy shifts attention away from acquisition-fueled growth to organic growth potential and profitability. This effort is expected to provide cumulative savings of about $10 billion in cost of goods sold, marketing expenses and non-manufacturing related overhead by 2016.
P&G kicked off the brand consolidation program with the sale of its remaining European pets food business in September 2014. With this sale, it exited the pet nutrition industry entirely. The major move in the brand consolidation program came in November 2014, when P&G announced the sale of the leading disposable batteries maker, Duracell, to Berkshire Hathaway. The $4.7 billion deal rid P&G of a sluggish business with low growth potential. It also exited its China-based batteries joint venture, which marked its exit from the disposable batteries business. Further, in December 2014, P&G announced the sale of its Camay and Zest soap brands to Unilever for an undisclosed sum.
In July 2015, P&G announced the bulk sale of 43 beauty brands to cosmetics company Coty Inc. in a $12.5 billion deal. The transaction will be structured as a Reverse Morris Trust for tax efficiency purposes and is expected to be completed in calendar 2016. Brands sold include marquee names like cosmetic brands Cover Girl and Max Factor, fragrances brands like Hugo Boss, Gucci and Dolce & Gabbana, and other hair styling brands.
Target to cut $10 billion in costs by 2016
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 core businesses
In light of declined earnings and recent market share losses in its core business segments, 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. 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. It should be noted that P&G is still expected to continue its geographical expansion plans, albeit at a slower rate than before.
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. However, the new manufacturing facilities are more a cost-control play rather than a measure to bolster volumes and revenues. As stated earlier, in the current scenario, P&G 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, in which it already has a presence. The focus in these markets
Nonetheless, as developed markets near saturation, emerging markets continue to grow in the high single digits (developed markets witness comparatively lower growth). New innovations and product launches with broad-based marketing support can quickly create significant opportunity for market share consolidation 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 invests about $2 billion annually in research & development, 60% more than its closest competitor, Unilever and more than most of its competitors combined. The high R&D outlay 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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- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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