In 2015 Procter & Gamble (PG, Financial) reported total sales revenue of $76.3 billion. In recent quarters the company’s topline sales have been consistently struggling. In 2015 sales revenue grew at a rate of -5% following 1% revenue growth in 2014. In a discussion at the Barclays Global Consumer Staples Conference, Jon Moeller, Procter & Gamble’s chief financial officer, provided his insight on the firm’s transformation and direction.
Current market environment
While sales have struggled across all of PG’s business categories due to lower global product demand, the firm has also faced considerable headwinds from the strengthened U.S. dollar. These two factors combined have showed Procter & Gamble’s vulnerability to global market competition and weakening global economies.
In 2015, the firm posted negative revenue growth in all of its business segments. Beauty, Hair and Personal Care and Grooming reported the company’s greatest segment losses. In Beauty, Hair and Personal Care revenue was down 7% to $18.1 billion in 2015. In Grooming sales were also down 7% to $7.4 billion for the year. The firm’s other three business segments also reported losses. Fabric Care and Home Care sales fell 5%. Baby, Feminine and Family Care sales fell 3%. Health Care sales were down the least for the firm in 2015, decreasing 1%.
In Jon Moeller’s comments he outlines PG’s high exposure to international markets which has greatly influenced its sales more than other comparable multinational companies.
“We have leading positions in some of the toughest markets in the world versus the next largest multinational competitor our business is over three times larger in Russia and the Ukraine, two times larger in Venezuela and Japan, where devaluation has had a significant impact, our business is six times larger than the next largest non-Japanese competitor. We are almost three times larger in China, where market growth has recently slowed. In the Middle East, which has been heavily impacted by political instability, war and the crash in oil prices, our business is two times our largest competitor,” says Jon Moeller.
These large geographic exposures combined with the strengthened dollar have weighed heavily on PG in recent quarters.
Undergoing a corporate transformation
In Moeller’s discussion on the firm’s transformation he talks about four main initiatives that he divides into two main focuses. The four main initiatives include productivity, supply chain, portfolio and rededication. The firm’s productivity and supply chain initiatives have been ongoing with results evidenced in 2015. The firm’s portfolio and rededication initiatives began primarily in July with the divestment of the firm’s beauty brands which are currently in the process of being acquired by Coty, Inc. (COTY, Financial).
Productivity and supply chain
In productivity and supply chain the firm is focused on production efficiency and reduction of costs. Despite the firm’s global revenue headwinds, it has managed to produce strong free cash flow to help it through this difficult time. In 2015 the firm generated $11.6 billion in adjusted free cash flow, with a productivity measure of 102% from the previous year. A free cash flow focus will continue in 2016 as the firm forecasts 90% to 100% free cash flow productivity for the year. Additionally, the firm is keeping a clear focus on returning value to its shareholders through dividends. In 2015 the firm increased its dividend for the 59th consecutive year, returning $11.9 billion in cash to shareholders.
Other significant productivity measures for the firm include a decrease in nonmanufacturing overhead and total manufacturing productivity. Since 2012 the firm has sought to reduce nonmanufacturing overhead by 16% to 22% over a four-year timeframe. The firm has exceeded this goal and is now on track to reduce nonmanufacturing overhead by nearly 30% through 2017. In productivity the firm has focused on new technology systems that improved manufacturing productivity by 5% in fiscal 2015. PG sees further improvements continuing in manufacturing productivity specifically as it employs more high-tech manufacturing solutions.
In supply chain management the firm’s heightened focus is also generating results. The firm has focused on reducing inventory and gaining more favorable payable terms. This has helped the firm reduce costs while improving product quality and process reliability. Additionally, the firm has added local distribution centers in international markets and moved many of its U.S. locations to major metropolitan areas. This has greatly helped to improve distribution costs both in the U.S. and internationally.
Portfolio and rededication
From a portfolio and rededication perspective the firm’s strategy is primarily centered around its beauty brands divestiture. In July the firm announced it would be selling 43 of its beauty brands to Coty for a value of $12.5 billion. The 43 brands that the firm is selling are part of the portfolio managed by Reverse Morris Trust. The products include global salon professional hair care and color, retail hair color, cosmetics, fragrances and select hair styling brands. The deal is expected to close in the first half of PG’s 2017 fiscal year.
Following the close of the transaction PG will focus its business on 10 categories which it feels have the greatest revenue generating potential.
“At the close of the beauty brands merger a year or so from now, we will have focused our portfolio on 10 categories, Baby Care, Feminine Care, Family Care, Fabric Care, Home Care, Hair Care, Skin Care and Personal Cleansing, Grooming, Oral Care and Personal Health Care. And about 65 brands that best leverage our core competencies where P&G has leading global market positions, strong brands and consumer meaningful product technologies from which we can grow and create value. We will be a company of superior brands and products in these 10 categories,” reports Moeller.
Furthermore, within these 10 categories, the firm’s four largest businesses include Baby Care, Fabric Care, Hair Care and Grooming. These four categories represent approximately 60% of the firm’s value and will be the firm’s more concentrated focus for future revenue growth.
Conclusion
While PG has several initiatives in place to improve margins and increase sales revenue the results are likely not to be seen until fiscal 2017. In 2016 investors can plan to see more of the same trend in sales revenue while the firm continues to use free cash flow productivity measures to maintain its current business. The weakened sales results have led to active selling from many investment managers. In 2015 Joel Greenblatt (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), Dodge & Cox and NWQ Managers (Trades, Portfolio) all reduced their portfolio positions in PG significantly.
While the company continues to pay out a steady dividend, its stock price has suffered, falling 24.49% year-to-date to a market price of $68.78. Given the weakened outlook and high business risks over the next year the stock has a discounted cash flow value of $62.30.
There are a lot of factors at work in the current environment that keep the risks high for PG. For investors, the important things to watch are how the cost reduction initiatives evolve and whether or not the new more concentrated brand portfolio will in fact produce the added sales revenue the firm needs to grow profitability. The clear strategic focus signals that PG’s transformation will help it emerge as a stronger company however for investors these results will not likely be seen until 2017 keeping the stock price volatile in the near term.
