Procter & Gamble: Refreshed Strategy Creating Turnaround Opportunity

Shifting focus means there is value investing potential

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Jul 05, 2018
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Recent third quarter results from Procter & Gamble (

PG, Financial) showed that the company continues to experience mixed performance. Although revenue moved 4% higher versus the same period of the previous year, it gained only 1% after being adjusted for gains made from foreign exchange changes.

The company’s grooming business saw organic sales fall by 3% due in part to price cuts and increasing competition. However, this was partially offset by growth in other areas, such as beauty. It delivered 5% organic sales growth versus the comparable period.

Core gross margin decreased by 110 basis points due in part to higher input costs, while core earnings per share increased by 4% to $1 after being boosted by reduced overhead expenses. Cash conversion was at 95%, with operating cash flow being $3.4 billion.

Challenging period

Given the mixed nature of the results, it is perhaps unsurprising that the company’s stock price is marginally down since they were released. In fact, the performance of the Procter & Gamble stock price has been disappointing over the last five years, underperforming the S&P 500 by 65% during that time.

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One difficulty facing the company is increased competition in the grooming segment. It makes up around 10% of annual sales for the business, and has come under pressure from cheaper alternatives that have resonated well with consumers. For example, Unilever-owned Dollar Shave Club is an online offering that is threatening Gillette’s dominance in the male grooming sector.

In response, Procter & Gamble has cut pricing across the Gillette range. While this helped to grow volumes by 1% in the first three quarters of the year, net sales dropped by 1% due to a 3% fall in pricing.

Online offerings have also hurt the company’s performance elsewhere. Traditionally, Procter & Gamble has relied on a dominant position in supermarkets and drug stores, where it has commanded vast swathes of valuable shelf space. Now, though, there is a trend among consumers to shop online, while smaller brands with more authentic stories behind their products are becoming more appealing versus major brands.

Changing consumer tastes have also caught Procter & Gamble off guard when it comes to organic and natural products. It has spent the past few years divesting around 105 brands from its portfolio, as it has focused on its more dominant brands that have higher margins. But with sales in the organic personal care market forecast to rise by over 9% per annum over the next couple of years versus around 3% for the overall personal care market, the lack of past investment in new, natural brands could prove to be a missed opportunity.

Turnaround potential

While Procter & Gamble may have disappointed in the past, its current strategy suggests that there could be turnaround potential ahead. In response to the challenges faced by Gillette, the company has sought to follow consumer trends by launching its own online shave club, while also investing in pricing. In addition, it has focused on innovation regarding its product line-up, reporting positive results from its changes thus far.

The company is also seeking to capitalize on the growth potential within the natural products space. As part of a pledge to minimize the impact of its products on the planet, new product launches are seeking to include natural ingredients. For example, Pampers Pure contain no chlorine bleach or fragrance and have become the biggest-selling natural diaper in the U.S. since launch.

As part of the drive towards following consumer trends when it comes to natural ingredients, the company is rolling out its SmartLabel offering. This could help to improve consumer confidence in its range of products and may help it to benefit from growing demand for natural products.

As mentioned, consumers are also increasingly shopping online rather than at supermarkets or drugstores. In response, Procter & Gamble is changing how it conducts its marketing spend. It will offer more focused online advertising, seeking to continue its strong growth in e-commerce transactions. Year to date, e-commerce transactions have risen by 32%, with the company outperforming the market in seven out of 10 categories. Further growth in e-commerce could help to boost its overall sales performance.

While there has been a focus in recent years on divesting brands, the business recently announced the acquisition of a portfolio of consumer health brands from Merck for €3.4 billion. Total revenue from the brands stands at almost $1 billion per annum, with strong growth currently being recorded. This could provide a catalyst for Procter & Gamble’s future financial performance.

Verdict

While Procter & Gamble has experienced a challenging period, it now seems to be putting in place a sound growth strategy. It is seeking to overcome difficulties in its grooming segment through responding to competitive pricing from online rivals, while its move towards more natural products and ingredients could allow it capitalize on changing consumer trends. More focused marketing spend and further e-commerce growth could also act as catalysts on its sales growth, while the acquisition of consumer health brands from Merck could also boost its financial performance.

Therefore, although it faces a number of challenges, the company seems to have the potential to overcome them. Following a disappointing five-year stock price performance, there could be a value investing opportunity on offer, with the stock having turnaround potential.

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