I know Jim Cramer is a lightning rod for investors, some investors cannot stand him and others sing his praises. Personally, I believe he has something to offer investors and watch his show Mad Money when I have the opportunity. I especially like his interviews with various CEOs and his take on the overall market. Like all market information, I take in what he has to say and then determine the value of it.
On the May 29th Mad Money, Cramer suggested investors should short Procter & Gamble (PG) and go long one of the other consumer product companies, like Unilever (UN), Colgate-Palmolive (CL) or Kimberly-Clark (KMB). Cramer's thesis was that former P&G CEO Bob McDonald had, after a slow start, finally begun to turn P&G around by announcing a restructuring and cutting costs. Many of the costs McDonald was cutting were built up during the previous CEO A.G. Lafley's regime. Cramer feels having Lafley back at the helm at P&G is a mistake and that the price run-up that followed the May 24th announcement that A.G. Lafley was returning was not warranted. Cramer stated P&G was overpriced and should be shorted. For the record, P&G's closing price Wednesday, the day of the show, was $78.90.
I differ from Cramer, in that I feel P&G is a giant that is turning many of its businesses around and has just started throwing its muscle into many of the emerging markets. With leading innovation and marketing, I believe P&G is set for several years of growth.
Why A.G. Lafley is the Right Choice
Bob McDonald took over as P&G CEO in July 2009, not the most opportune time, as the world was in the middle of the Great Recession. During this time, P&G suffered lost sales as many consumers switched to lower priced brands. McDonald's attempt to revitalize P&G's sales never gained any traction and pressure from investors grew, leading to what appears to be a forced retirement and the return of popular former CEO A.G. Lafley.
Below is a chart that shows some of the key business results during McDonald's tenure. The numbers were taken from the P&G 2012 Annual Report
|Net Earnings Margins||11.1%||14.4%||14.0%||14.1%|
|Diluted Net Earnings per Share||$3.66||$3.93||$4.11||$4.26|
I believe any objective observer would say the results have not been strong under McDonald. Declining earnings, declining income and declining margins at a time when many of the world economies are improving is not what most investors are looking for.
A.G. Lafley was CEO from 2000 through 2009. He was known for pushing innovation and was also responsible for the Gillette acquisition in 2005. When Lafley took over in 2000, P&G, much like it is today, was struggling. P&G was missing projected earnings and even leading brands like Tide were struggling. Lafley turned the company around, growing sales from $40 billion in 2000 to $81 billion in 2008, his last full year as CEO. During his reign, earnings grew from $2.47 a share in 2000 to $3.64 in 2008 and the stock price doubled.
Again, I believe an objective observer would say those were good results. If you were part of an executive search panel, would you select the person who had Bob McDonald's results or would select the person that had A.G. Lafley's results.
In my opinion, a CEO's most important quality is to have a vision of where he/she wants to take the company. He/she then must communicate and execute that vision. Lafley had a vision, he communicated that vision to the P&G employees and they all executed that vision.
In the P&G 2001 Annual Report, Lafley laid out these five priorities to grow P&G sales:
- 1 - Build existing core businesses into stronger global leaders.
- 2 - Grow big brands, big countries and leading customers.
- 3 - Develop faster-growing, higher margin, more asset efficient businesses with global leadership potential.
- 4 - Regain growth leadership and momentum in Western Europe.
- 5 - Drive growth in developing markets.
He delivered on all those goals.
Bob McDonald lacked vision; he got caught up worrying about side issues like sustainability and reducing energy costs. Those are all nice things, but reducing packaging size is not growing sales.
In P&G's 2010 Annual Report, Bob McDonald wrote the following about P&G's purpose.
"Our Purpose is tightly and deliberately linked to our business and financial goals: P&G's Purpose inspires our strategic choices; it leads us to bigger and better innovation; it drives brilliant execution; and it compels us to make a difference in areas such as sustainability and social responsibility not merely to be a good citizen, but more importantly, to create future opportunities to touch and improve lives-and, in so doing, to keep our Company growing."
McDonald went on to add "Last year, we updated P&G's growth strategy to connect it explicitly to our Company's Purpose." To my eyes, that is not a clear vision.
I fully expect A.G. Lafley, once he gets up-to-speed on P&G's various business units, will again issue a clear concise vision on how to grow P&G.
For years P&G promoted its brands as "best in class" and in many cases they were. Tide, Pampers, Charmin, Duracell, Gillette, etc. are all quality brands that consumers trust. Because they were quality brands that consumers desired, P&G was able to charge a premium price. In 2008, all that changed. A deep recession swept through the world and consumers were strapped. Looking to save wherever they could, consumers began choosing lower priced brands. Finding that those cheaper brands were "good enough" consumers were no longer brand loyal, preferring to buy what was cheap. Because P&G had limited products in the lower priced category, sales and profits fell and have not completely recovered.
Here is a statement from the 2012 Annual Report that explains P&G's cost issue.
"Our growth in developed markets has been weaker, resulting from slower market growth and declining market shares. The share declines in these markets were driven primarily by consumer value issues on key brands in several large categories due to a combination of price increases taken to recover higher commodity costs, which our competitors did not take, and increased promotional activity by competitors."
P&G has many business lines, some of which, oral care, shaving, fabric care and health care, have performed well. Others, mostly notably beauty care, have struggled. Below is a statement on the struggles in the beauty care segment from the latest P&G quarterly earnings report:
"Net sales decreased in Hair Care and Skin Care in a period of heavy competitive product and promotional activity. Organic sales increased in Salon Professional driven by strong innovation performance, partially offset by market contraction."
Everyone agrees Procter & Gamble makes innovative high quality products. The question is, can P&G maintain the margins it once did? Or, will it have to cut prices to fend off competitors who are willing to live with smaller margins.
Several months ago, Bob McDonald announced a $10 billion cost savings program, described in the 2012 report as follows:
"Earlier this year, we announced our objective of delivering $10 billion* in cost savings by the end of ﬁscal year 2016. This program includes $6 billion of savings in cost of goods sold, $1 billion from marketing efficiencies, and $3 billion from non- manufacturing overhead."
Cost cutting in a company as big as P&G is always a positive and $10 billion in savings by 2016 is substantial. But, cost cutting alone won't improve sales and increase margins. That will take increased innovation, better products and better marketing. It is those skills that A.G. Lafley brings to the company. During his first reign as P&G CEO, he had a mantra, "the consumer is boss". Lafley sent P&G workers into consumer homes to find ways to make their lives better. This focus on the consumer is what P&G needs, rather than developing a product and convincing the consumer they need it, it is better to have the consumer tell you what they need.
P&G has had some success in emerging markets; India, where P&G has grown sales double digits for 43 consecutive quarters, is an example. However, in other markets it has struggled and in some cases, companies like Unilever have beaten P&G to the market and have secured shelf space and customer loyalty. P&G will have to exert its size and its supply chain logistics advantage to win the battle in the emerging markets.
P&G has also improved its product lines by offering some products at lower price points. For example, P&G has kept Tide, the leading laundry detergent, at a higher price point while offering Gain at a lower price point. Both Tide and Gain have seen positive sale trends. P&G will continue to look for ways to provide products at the various price points consumers need.
If P&G can continue improving current products and creating new products, muscle its way into a leading position in the emerging markets, and improve its marketing, I believe it can grow the company in the mid-single digits for a long time.
There is one last ingredient that will improve the outlook at P&G and that is an improving world economy. In many cases, P&G products are the products consumers aspire for. A little higher priced, but with the price comes higher quality. An improving world economy will put a little bit more spendable cash in consumers' pockets which they may use to buy the products P&G offers.
Why I am Going Long P&G
I believe the return of A.G. Lafley, continued cost reduction, an improving world economy, continued innovation, greater emphasis on emerging markets and a world population that will continue to grow by the hundreds of millions will lead to decades of mid-single digit growth. I also believe P&G's long history of dividend growth and share buy-backs will continue. Like many of the stocks I own, P&G will not skyrocket overnight, but it will provide decades of slow price appreciation and growing dividends.
Jim Cramer has been a hedge fund manager and has his own television show. He probably knows more than I know, but in this case I will take the opposite side of the trade and go long P&G.