Procter & Gamble (NYSE:PG) stock has fluctuated in the $50-70 range for an extended period of time. It has also seen a slowdown in organic sales growth over the past few years, primarily due to price increases which have only partially offset the resulting decline in market share and volumes. Emerging market growth is expected to remain flat going forward as the company has decided to scale back on its expansion plans. It is now increasingly looking towards cost-cutting strategies to generate value, either through higher margins or competitive pricing.
Expansion into Emerging Markets Has Stalled
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A core part of P&G’s business strategy is to meet its financial targets through above-average growth in emerging markets. The company’s emerging market operations now make up around 40% of its total sales and 45% of unit volumes. It continues to see double-digit growth in markets such as India (21%), Russia (18%) and Brazil (17%), and China is now its second biggest market (6% of sales).
However, while presenting at the Deutsche Bank Global Conference in June this year, CEO Bob MacDonald admitted that slowing growth in the developed markets, which account for 60% of net sales and even more of profit, has led the company to revise its emerging market expansion plans. It will now focus only on the top 10 prospects, namely India, China, Brazil, Russia, Mexico, Turkey, Poland, Indonesia, South Africa and Nigeria.
The company faces intense competition in these markets, especially from rival consumer goods producer Unilever (NYSE:UL), which now generates over 56% of its total sales from emerging markets. P&G is still the market leader in most segments, but Unilever has caught up and looks set to overtake it. It also faces competition from local firms, which have a number of inherent advantages.
Cost Cutting Strategies to Generate Value
P&G has increased overall pricing by over $3.5 billion over the past few quarters, in order to offset similar increases in commodity costs. About $400 million of these price increases were rolled back through price cuts and promotions. The problem is, however, that competitors have not taken pricing, and this has led to declining market share and volumes for a number of business segments.
Earlier this year, P&G outlined a restructuring plan to reduce costs by $10 billion by 2016. This involves reducing overheads by $3 billion, cost of goods sold by $6 billion and marketing expenses by $1 billion.
The company incurred over $700 million in restructuring expenses during the previous financial year and has estimated total expenses of $3.5 billion by the end of fiscal 2015. Almost half of this amount is expected to be incurred by the end of fiscal 2013. These costs are expected to result in before-tax annual savings of around $2 billion.
There have already been slight increases in core margins due to productivity improvement and cost savings. In the previous quarter, core gross margins grew by 10 basis points y-o-y, in spite of increasing commodity costs and foreign currency impacts. Core operating margins increased by 90 basis points, primarily due to lower core SG&A costs.
One reason why its cost cutting strategy may be a success if executed effectively is that it would enable P&G to price its products more competitively. The company has a long history of innovation, with a legacy of market disrupting products which have allowed the company to command higher pricing.
Innovation, however, has slowed in recent years, partly due to lower R&D expenses as a percentage of revenues, but P&G has continued to increase pricing due to increasing commodity costs. The cost-cutting strategy would enable the company to regain some of its lost market share through competitive pricing while keeping margins intact.
On the other hand, if prices remain unaltered, the cost cutting could result in higher margins. If the cost cuts go entirely to the bottom line, there would be a 10% upside to our price estimate, all else constant.
We currently have a Trefis price estimate of $69 for P&G, which is in line with the market price.