When a candle maker and a soap maker became business partners in 1837, no one could have guessed how big their company would become. But when these two unlikely millionaires-to-be came together, an infant giant called Procter & Gamble PG was born. The real mastermind behind P&G was their common father-in-law who was instrumental in bringing these two brilliant minds together.
As early as 1859, P&G became a million-dollar company, but the real shot in the arm came with the civil war. As the war raged on, the company supplied the Union Army with two essentials that will never go out of style - soap and candles! Out of that early opportunity was born the company's reputation as an innovative manufacturer of goods that bring value to their customers' lives.
Innovation Takes Center-Stage
Take their first unique product - Ivory - as an example. This was a soap that floated on water! If that sounds like a crackpot invention that went the way of the dinosaur, don't forget that the dinosaurs ruled the earth for millions of years. Today, Ivory still contributes 1% of the company's total revenue: not bad, when you realize that it equates to more than $800 million a year for a product line that is more than 120 years old!
Here's another example of innovation that put P&G at the top of the consumables pecking order and planted it firmly in the annals of popular culture. During the 1920s and 30s, when radio was becoming the home entertainment medium of choice, the company aired advertising that supported some of the most popular shows. Because P&G was generally known as a soap company, people started calling these programs 'soap operas' - and the name stuck.
Bruce Brown, CTO at Procter & Gamble, is well aware of the company's reputation for innovation. In fact, he's very much a part of it. In an interview with Forbes in 2012, his stand was very clear: "The consumer is the boss." Not the company's reputation, its best practices or even its most innovative products; it's the market that guides development.
As such, P&G has deeply ingrained into its employees the concepts of inter-departmental collaboration and actively being involved in market sensibilities around the world. Crest WhiteStrips is a perfect example of this. The product uses film from the paper products department; the whitening agent from the fabric department; and the glue from a completely different product line. With cross-pollination constantly being at the forefront of discovery, it's no wonder that P&G comes up with ideas that others haven't even dreaming up.
Now, let's see how this innovative approach affects the company in the long run. Innovation is good, but when size overwhelms, it's time to divide and conquer. Whether or not this is true might be a subjective call, but figures don't lie.
The Bigger the Size, the Slower the Growth
Procter and Gamble's biggest problem is its size. With net sales of $84 billion in 2013, PG is much bigger than most companies. Even if it sets a target of growing 4 to 5 percent for the next year, that translates to another 4 billion in sales. This is NOT an easy task to achieve even for a company with all the resources in the world at its disposal; it's going to get a bit difficult moving forward.
Procter and Gamble operates in approximately 180 countries, which makes it dependent on global economic growth. Developed markets (North America and Western Europe) account for 57% of sales. This market is saturated and the only way personal product manufacturing companies can increase their market share is through innovation. Developed markets will obviously grow at a more subtle pace when compared to developing or emerging markets. In saturated or developed markets, innovation is often the only way to gain additional market share; furthermore, at no point can P&G can afford to lose its current market share, as it will be nigh impossible to win it back from heel-snapping competitors. It can also add new revenue streams by venturing into new business segments.
To achieve the hypothetical 5% sales growth target, therefore, a large portion of its revenue has to come from markets that are growing at a fast pace. P&G was admittedly a bit slow to enter emerging markets. For example, Unilever has been operating in India for a very long time. Though PG was late, they have picked up the slack and are competing hard to increase their penetration. Emerging economies will be the key growth drivers for both P&G and Unilever. Whoever wins the race will be able to keep increasing their sales for a long time. A lot of people talk about currency fluctuations and the strengthening dollar eroding the benefits of emerging market sales, but these things only have short-term impact, at best. As a business leader, you would much rather P&G became a market leader in all these countries and gain in the long-run, than worry about foreign exchange impact that may hit your numbers for a few months or even years.
P&G, however, may not have enough ammunition to enter into a price war with Unilever (UL) or Colgate-Palmolive (CL) in these markets. Which makes all three companies vulnerable to margin erosion whenever they try to out-do each other by adjusting prices. Once again, innovation and localization of products will be the key to win market leadership in fast growing economies. P&G seems to have mastered this, but will it be enough? You can analyze our take on Unilever here
How Fast Can It Grow In The Next Ten Years?
In 2004, PG's total sales were $51.4 billion, and it stands at $84.167 billion as of 2013 - a ten-year compounded annual growth rate of 5.63%. If global economy keeps growing at 3% to 4 % range for the next ten years, it shouldn't be impossible for P%G to grow in the range of 5 to 6%. However, a lot will depend on their ability to hold their market share in developed markets, as well as increase their market share in developing markets.
P&G and Innovation
We are talking about a company that has always been at the forefront of innovation. They have introduced a laundry list of breakthrough products which literally changed our lifestyles. Pampers is a relatively recent example; but, of late, P&G has not delivered much from its labs.
I would personally prefer P&G getting back to old levels of concentration on innovation. At this size they can ill afford to stop bringing in new breakthrough products to the market. Extending existing product lines is not bad - but that's only going to marginally increase your sales; whereas, a great new product can deliver better margins as well as better sales.
P&G is a great company with solid financial managers who know how to keep their balance sheet clean.
Valuation - The Verdict
P&G is a hold for sure (duh!). With a current P/E of 20, P&G does look a bit expensive. But it's a great company with great products. It only needs better strategizing to move forward. The sheer quality of its existing products will help the company hold its ground but, if it wants to grow, it needs better-functioning labs and more efficient operations. If you already own the stock, please hold it and keep an eye on their new product releases. If you are planning to buy, then you can get in during market weakness, preferably when P/E is below 18.