Can Procter & Gamble Return to Growth?

Consumer processed goods behemoth Procter & Gamble (NYSE:PG) has been plagued by low organic revenue growth in the last few quarters. It failed to meet consensus EPS estimates in each of the last four quarters. ^[1] Investor sentiment in the company has fallen, contributing to a decline of 15% in the P&G’s share price over the last 12 months. Investors and industry analysts have repeatedly raised the question of whether P&G is doing enough to revive growth.  We wonder, will its measures in fact bear fruit and if so, when? We believe that a combination of an adverse macro environment and the ongoing restructuring activities will continue to hurt the company’s performance over the next year. However, P&G is taking concrete steps in the right direction, which are likely to pay off in the long run.

In this report we take a look at the problems that P&G is facing, the steps it is taking to address them, and whether those steps will help it return to growth in the future.

Our price estimate of $76 for Procter & Gamble is about 10% higher than its current market price.

See our compete analysis for Procter & Gamble here

Tough Decisions in a Difficult Time

Procter & Gamble’s results were battered by heavy currency headwinds throughout fiscal 2015. (Fiscal years end with June.)  In an attempt to offset the damaging impact of adverse currency movements, P&G raised prices across the board throughout the year, which led to a decrease in volumes. (Read: P&G’s Near-Term Outlook Darkens as Volumes Drop in Q4) The management has stood by its decision to raise prices as it believes that protecting margins is more important than volume growth for long term value creation. ^[2] However, we believe that P&G could be better served by maintaining a balance between volume growth and margin accretion, as aptly demonstrated by its biggest competitor, Unilever (NYSE:UL). The slump in organic revenue growth was further exacerbated by currency headwinds, causing an erosion of shareholders’ confidence and led to the slump in P&G’s share prices.

Further, P&G has been reinvesting the savings achieved from higher pricing and productivity improvements into supply chain improvements and innovation. As a result, the benefits achieved from its robust productivity improvement measures were not reflected in the fiscal 2015’s bottom line. The company intends to continue along the same track and invest in supply chain transformation and innovation in the near term.

The combination of sluggish organic revenue growth, heavy currency headwinds and poor margin improvement has created something of a perfect storm for P&G, causing significant concerns among investors. The question is, will P&G come out of this storm and return to the land of revenue growth, margin accretion and value creation? We believe it will.

Short Term Pain for Long Term Gain

In the Barclays Global Consumer Staples Conference earlier this month, P&G CFO Jon Moeller acknowledged investors’ concern that the company’s turn-around ilagging. He stated that the transformational changes that P&G is going through are still under progress and still roughly a year away from completion. Consequently, it will be some time before the benefits of these changes become apparent in the company’s results. ^[3]

We believe that the company may have chosen to accept some short term pain for the sake of long term sustainable growth. P&G’s reinvestment of savings into its supply chain and innovation programs put it in a good position to come out swinging once the dust from the portfolio reorganization and macro uncertainties settles. A closer look at P&G’s financials shows that its efforts have indeed had concrete effect, but have not been reflected in the bottom line simply because of the reinvestment of savings. For instance, P&G’s inventory turnover ratio has increased from 10.5 in calendar 2010 to 12.3 in calendar 2014, including a 12% improvement in 2014. A high inventory turnover ratio implies effective inventory management, which the company has been trying to achieve by reducing the inventory levels in the supply chain.

Similarly, P&G has also improved its accounts payable days as part of the supply chain transformation, achieving a 10% improvement in calendar 2014. The company reported in the Barclays Global Consumer Staples Conference that its supply chain financing program has yielded a cumulative $2.3 billion so far, with another $1 billion expected over the next two years. ^[3] These are strong measures that are likely to provide operational advantages over the long term.

In the case of innovation, P&G’s renewed focus on groundbreaking product innovation has yet to be reflected in the results because the company has stepped up its R&D investments only over the last year. The innovations born of this renewed focus are expected to be introduced over the coming months. According to the company, among the upcoming products is the “most significant innovation in the hair care category” since 1991. ^[3] Since P&G will now focus primarily on the premium category, strong adoption of the new products could result in more profit per unit and thus bolster the bottom line.

Focus on Shareholder Value Remains Intact

Procter & Gamble has been historically regarded as a champion of building shareholder value through steady dividend growth, consistent share repurchases, and well thought out reinvestments. We believe that this focus of the company has not changed. This was evident in the agreement to sell 43 of its beauty brands to Coty earlier this year — the brands being sold account for 7% of P&G’s revenues, yet the non-GAAP earnings teargets remain unchanged over the long term. (Read: The $12.5 Billion Sale of Beauty Brands Could be the Herald of a New Era for P&G) Further, the company also plans to return a mammoth $70 billion to shareholders via dividends and share buybacks over the next four fiscal years, beginning 2016. Notably, the company intends to utilize the cash realized from the Coty and Duracell transactions to fund this plan and maintain its credit rating in the process. ^[4]

There have been concerns that in order to maintain its history of consistent dividend hikes, P&G is utilizing a higher percentage of its profits to fund the dividends. This is evident from P&G’s dividend payout ratio, which has shot up from 35% in 2008 to 75% in 2014. This is obviously due to a decline in profitability of the company – its non-GAAP net profit margin has contracted from 18% in 2008 to 13% in 2014. However, we believe that the transformational measures mentioned in the previous section and the portfolio organization focused on premium category products could provide a substantial breather to P&G’s bottom line over the medium to long term. Once profit margins are back on track, the sky-high dividend payout ratio will likely to subside back to historical levels.

In conclusion, we believe that P&G is headed in the right direction with concrete steps to address its shortcomings. Some turbulence is likely to continue in the year ahead as the transformation is full avhieved. But over the long term, in our view, P&G’s current measures should place it in a strong position to revive revenue growth as well as margin expansion.

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More Trefis Research

1. Yahoo Finance [↩]
2. Procter & Gamble Fiscal 2015 Fourth Quarter Earnings Call Transcript, Seeking Alpha, July 30, 2015 [↩]
3. Procter & Gamble at Barclays Global Consumer Staples Conference Transcript, Seeking Alpha, September 10, 2015 [↩] [↩] [↩]
4. P&G Accepts Coty’s Offer of $12.5 Billion to Merge 43 P&G Beauty Brands with Coty, Procter & Gamble Press Release, July 9, 2015 [↩]