This year will be transition year for Procter & Gamble (NYSE:PG) as it reshuffles its priorities to recover market share and operating margin losses in its core and more profitable developed markets. The deceleration of emerging markets expansion marks a significant departure from P&G’s previous growth strategy of adding new product-market categories to help expand to 5 billion customers – which was a key priority for CEO Bob McDonald.
P&G has been losing margins over the past three years amid high costs, competition and weak economic growth. But the recent market share losses, in contrast to competitors like Unilever (NYSE:UL) that have performed better despite the same market challenges, have made investors restless, creating significant pressure on the consumer giant to show improvement in performance over the next few quarters.
Overextended Itself With Fast Paced Expansion In Emerging Markets
P&G had accelerated its emerging market expansion over the past three years to make up for the sluggish demand from developed markets. However, the high commodity cost environment, expansion expenses and supply-chain shortages in the developing markets has made the expansion more costly than previously expected. As a result, despite resorting to some pricing increase every quarter to offset commodity cost pressure, the company-wide EBITDA margins continued to fall sharply from 26.5% in 2009 to 23.9% in 2010 and 22.3% in 2011, accentuated by disproportionate growth in developing markets. Emerging markets currently account for about 37% of P&G’s annual sales, up from 20% in 2000.
Doubts were raised on P&G’s strategy after it reported poor results last quarter, suffering market share losses in its core markets and product categories and unimpressive margins, even as Unilever posted double digit sales growth with market share gains in personal and home care categories, despite cost and demand headwinds.
Investors Eager For Signs Of Improving Trends
In February 2012, P&G announced an ambitious productivity and cost savings plan to reduce spending across all divisions by up to $10 billion by 2016, which will include a $1 billion reduction in marketing costs and $3 billion in overhead expenses. The target therefore seems to rely on a larger improvement in operating margins coming from commodity costs moderating.
The company is now focusing 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. Even though its further expansions are likely to be more measured, with focus on ‘self-funded’ expansions, we do not expect it to let go of its position in its 10 largest emerging markets including China, India, Indonesia, Brazil and Russia.
Our current $70 price estimate for P&G assumes an average 4% sales growth over the forecast period and the EBITDA margin to improve from current 22% level to exceed 23% by 2016. We could see be a 5% upside to our price estimate if the company manages to achieve its 2007-08 margin level of 24-25%. On the contrary, there could be a 5% downside if the margin improvement is modest or the margins continue to stay at current levels.
We currently have a $70 Trefis price estimate of P&G’s stock, 10% ahead of the current market price.