Here’s How P&G’s Brand Consolidation Program Could Backfire and Push Its Valuation Below $60

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PG: Procter & Gamble logo
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Procter & Gamble

Last year, leading consumer processed goods company Procter & Gamble (NYSE:PG) embarked on an ambitious brand consolidation program to revive its flailing growth. Under the program, it plans to dispose of about 100 brands out of its portfolio of 165 brands by the end of this summer (Read: P&G Expects Brand Consolidation to be Over by Summer). The strategy is designed to help P&G focus on its biggest and best performing brands, which have the most growth potential and highest margins. The move has been widely lauded by investors and analysts alike. However, it leaves P&G with a few glaring chinks in its armor — chinks that indeed threaten its stock price. Consider the following:

The foundation of P&G’s strategy lies in getting rid of dead weight and focusing on the few products and markets that have the most growth potential. This would result in higher growth and better margins in an ideal economic scenario. However, it also rids the company of a key survival aspect for any global conglomerate in an economic downturn – diversification.

In this report, we take a look at how the loss of diversification due to the brand consolidation program could result in a significant downside to P&G’s valuation.

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We have a price estimate of $78 for Procter & Gamble, which is nearly the same as its current market price.

See our complete analysis for Procter & Gamble here

The Brand Consolidation Program

When CEO A.G. Lafley embarked on the ambitious brand consolidation program last year, P&G was plagued by dozens of under-performing brands which were dragging down the company’s growth. Consequently, Lafley’s bold move to sell, split, discontinue or otherwise divest a hundred brands, which is 60% of P&G’s brand portfolio, was universally well received. Since the announcement last year, P&G has discontinued or planned the consolidation of 40 of the total 100 brands set to be sold. ((P&G Deutsche Bank Conference Call Transcript, Seeking Alpha, June 11, 2015))

According to P&G, the 65 brands remaining after completion of the program will be concentrated across just 10 product categories. Geographical concentration is also expected to be higher, as the top 5 countries of each category will account for 54% to 98% of total global profit of that category. ((P&G Deutsche Bank Conference Call Transcript, Seeking Alpha, June 11, 2015)) As a result, P&G will be able to transform itself into a far leaner organization with minimal loss of revenues.

Brand Consolidation May Lead to Lack of Diversification

The very characteristics that P&G is advocating as the benefits of its strategy, could turn into a major liability in case of an economic downturn. Diversification spreads a company’s risks across sectors and geographies, which protects the company during cyclical economic upheavals. To the contrary, P&G is planning to derive a bulk of its revenues and profits from a small set of product categories and geographical regions. This leaves the company exposed to downturns in those product categories and geographical markets.

For example, significant adverse movement in any of the company’s top five geographical markets could cause substantial revenue and margin erosion. Earlier, the impact of such a scenario would not be as high because the company would have a relatively small presence in a large number of geographical markets. On the other hand, post-consolidation, P&G will derive at least half, and in some cases almost all, of its profits from just 5 countries. A major economic, political, currency or other instability in any one of these countries could result in a disproportionate impact on P&G’s overall performance.

Therefore, we believe that by opting to concentrate on a few product categories and geographical markets, P&G just might be selling not just its under-performing brands, but also the protection from diversification.

Impact of Economic Downturn on P&G’s Valuation (25% Downside)

P&G operates in the consumer processed goods sector, which is closely linked to consumer spending. In turn, consumer spending is closely linked to economic growth of the country. Therefore, an economic downturn would have a direct and proportionate impact on P&G’s revenues.

For estimating the impact of such a scenario on P&G’s valuation, we have assumed a slump in consumer spending over the medium term, with a modest recovery towards the tail end of our forecast period. The impact of a drop in consumer spending is reflected in lower growth of the markets that P&G competes in. A comparison of the market sizes in the base case and in this scenario is provided below:

P&G's Market Share

For the purpose of this estimate, we have kept P&G’s market share the same as our base case scenario. This is because we believe that P&G will be able to retain its market share through a combination of lower prices and customer stickiness in segments like baby care, family care, and feminine care. The slashed pricing is expected to result in a decrease in EBITDA margin across the board, as compared to the base case. Consequently, we estimate P&G’s total EBITDA margin to fall to 20% by 2021, compared to 24% in the base case.

Further, P&G will be forced to scale back any expansion plans due to lower sales in the poor economic scenario. Consequently, we have reduced our estimate of P&G’s capital expenditure as a percentage of EBITDA in this scenario. Currently, we expect P&G’s capital expenditure as a percentage of EBITDA to decline from 21% in 2014 to 17% in 2021. We estimate it to fall to 14% by 2021 in the aforementioned scenario.

In such a case of a decline in market growth, leading to a fall in P&G’s EBITDA margin and capital expenditure, there could be a 25% downside to the company’s current valuation.

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

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