Procter & Gamble's Management Presents at Morgan Stanley Global Consumer & Retail Conference (Transcript)

| About: The Procter (PG)

Procter & Gamble Co. (NYSE:PG)

Morgan Stanley Global Consumer & Retail Conference Call

November 19, 2013 8:35 a.m ET

Executives

Jon Moeller – CFO

Analysts

Dara Mohsenian – Morgan Stanley

Dara Mohsenian – Morgan Stanley

I'm Dara Mohsenian, Morgan Stanley's household products and beverage analyst. And we are very pleased to welcome Procter & Gamble here today, including Jon Moeller, Procter's CFO and John Chevalier in Investor Relations. There have certainly been a number of changes at Procter recently with the new CEO, as well as a large restructuring program, which has generated some significant cost savings that has driven a pickup in earnings growth. So we are excited to hear more about the changes today and I'll turn things over to you, Jon.

Jon Moeller

Thank you, Dara. Let me get situated here. I'm going to start this morning with a brief overview of our recent results and outlook. I will then outline areas we are focusing on to further improve results and I will spend a few minutes on an update of our beauty and our healthcare business. July-September organic sales grew 4% driven by strong organic volume growth of 4%. Organic sales were in line or ahead of a year ago in all reporting segments. They were up 8% in developing markets and up 1% in developed markets.

P&G global market value share was stable at around 20% for the most recent three-month period. We held or grew global market share in businesses representing about two-thirds of global sales. Core earnings per share were $1.05, down $0.01 versus the prior year. These results include a $0.09 per share headwind for foreign exchange. On a currency-neutral basis, core earnings per share was up 8% for the quarter. We repurchased $2.5 billion in stock and returned $1.7 billion of cash to shareholders in dividends.

We are maintaining our organic sales growth guidance range of 3% to 4%. Achieving organic sales growth in the upper half of our target range should result in modest overall market share growth. We continue to expect currency to be a sales growth headwind of about 2 points leading to all-in sales growth in the range of 1% to 2%.

Our forecast for core earnings per share growth remains at 5% to 7%. This translates to constant currency core earnings per share growth in the range of 11% to 13%. On an all-in GAAP basis, we expect earnings per share to grow approximately 7% to 9%. First-half core earnings per share growth will likely be about flat.

Second-half growth will be much stronger. Our second-half growth forecast is not based on significant acceleration and organic sales growth. The second-half earnings acceleration is driven by foreign exchange and cost structure. Foreign exchange is a significant headwind in the first half, but will moderate in the second half if recent spot rates hold. This is especially true for the Japanese yen and Venezuelan Bolivar, which combined drove roughly 40% of the negative impact in the first quarter. We estimate that about 70% of the fiscal year FX impact will be in the first half of the year.

Manufacturing and startup costs will largely annualize in the back half and productivity savings will build throughout the year. This will all lead to improved gross margins and operating margins in the second half. As you review your estimates for Q2, please recall the second-quarter base period includes $0.07 per share one-time gain from the sale of the Western European bleach business. The foreign exchange headwind for Q2 is expected to be similar to the impact we saw in the first quarter. We are also expecting a heightened level of competitive promotional spending ahead of our product initiatives launching early next calendar year, especially in North America fabric care and beauty.

We are targeting 90% free cash flow productivity. We expect to pay over $6.5 billion in dividends and repurchase $5 billion to $7 billion of our stock, continuing to deliver on our commitment of cash returned to shareholders. On a market cap of about $220 billion, this equates to an effective shareholder yield of approximately 5% to 6%.

We're focused on four areas to drive further improvement in our results. Value creation for consumers and shareowners is our top priority. Operating TSR is our primary business performance measure. Operating TSR is an integrated measure of value creation at the business unit level requiring sales growth, progress on gross and operating margin and strong cash flow productivity. Operating TSR drives focus on core businesses, our leading, most profitable categories and leading most profitable markets.

Our strongest business unit and total company positions are in the US. We need to continue to ensure our home markets to stay strong and is growing. We will continue to grow and expand our business in developing markets with a focus on the categories and the countries with the largest size of prize and the highest likelihood of winning. Developing markets will continue to be a significant growth driver for our Company. We will continue to focus the Company's portfolio, allocating resources to businesses where we can create value.

Innovation and productivity are the two biggest drivers of value creation. Innovation has always been core strength for P&G. We are committed to make productivity a core strength, systemic, not episodic. We'll measure productivity, we will recognize it, we will reward it. Productivity is particularly important in the slower growth world and in an environment of increased volatility.

More productivity means more opportunities to invest in core business growth, in developing market expansion and in innovation. We expect this fiscal year to be another year of strong productivity improvement versus a target run rate of $1.2 billion, we are planning more than $1.4 billion of cost of good savings this fiscal year across materials, logistics and manufacturing expense. We expect to improve manufacturing and productivity by at least 6% this year. We are up more than 8% fiscal year to date.

We expect to deliver our 2014 enrollment reduction goals around the end of this calendar year and then we will work to accelerate roll reductions planned for fiscal 2015 into 2014. There are several teams supported by external advisors and benchmarks working in parallel on plans to deliver these reductions. The teams span business sectors, market development organizations and corporate functions. We're hoping to consolidate individual team plans into one overall company plan at the beginning of next calendar year and plan to discuss key elements with you at the CAGNY conference in February.

We continue to drive marketing ROI improvements. Our return on our marketing investments measured in sales ranges from less than $1 to over $25 for every dollar invested. We spend roughly $14 billion annually in advertising and non-advertising marketing spending. If we increase the return on the spending by just $0.50, we could free up several billion dollars to either reinvest or take to the bottom line.

The third area of focus is improved execution and operating discipline. We simply have to execute better, more consistently and more reliably every day, everywhere to win with consumers and customers. It's not about exhorting the organization to do better. It is about rigorously following tried-and-true work processes that deliver results. It's about only airing high ROI advertising. Its disciplined launch qualification and planning. It's about staying ahead of changing regulatory standards to ensure we maintain full supply capability. It's about everybody playing their position and playing it well.

The fourth priority involves strategic investments in innovation and go-to-market capability. Budget increases in R&D will enable us to strengthen our near and mid-term innovation pipeline. Go-to-market investments will improve sales coverage in our fastest-growing markets and fastest-growing channels. We believe that the focus we are bringing to these four areas – operating TSR, productivity and innovation, operational excellence and targeted investment in R&D and go-to-market capability – are important and will lead to improved performance.

At the Barclays conference in September, we provided perspective on our household and paper businesses. Today, I will provide some additional perspective on beauty and healthcare. First, beauty, where we have a long track record of profitable growth. Over the last 25 years, P&G has built the largest and most profitable beauty and grooming business in the world. Pantene and Olay were small brands with less than $100 million of sales when they came to P&G as part of the Richardson-Vicks acquisition. We have built them both into global leaders.

Our fragrance business has grown from about $20 million to over $2 billion in sales. SK-II have sales now over $1 billion versus $100 million at acquisition. Old Spice was primarily a regional brand with around $100 million in sales when we acquired it. It's now over $0.5 billion in sales globally. More recently, we stumbled on Pantene in North America and on Olay, which has offset the progress in other segments of the business.

Personal cleansing shipments increased high single digits for the last two quarters and global value share has grown versus a year ago for the past three and six months. Growth has been strong in the US with value share up over a 0.5 point in the September quarter driven by commercial and product innovation on Olay and Old Spice and the introduction of Herbal Essence's body wash. China has also seen strong growth with shipments up mid-teens last quarter behind new packaging and product upgrades across the Olay personal cleansing lineup, creating a more relevant and easier to shop brand architecture. Safeguard has been a great long-term growth story with high single digit global sales growth over the last three, five and 10-year periods driven mainly by very strong growth in China.

Another strong beauty business is antiperspirant and deodorants. Last quarter, shipments grew mid-single digits building on a strong fiscal 2013 where shipments were up mid-single digits for the year. In the September quarter, US deodorants' value share grew more than 1.5 points versus a year ago. This was driven by the recent introduction of Secret Stress Response as part of the premium Clinical Strength line and the introduction of the Wild Collection on Old Spice. Let's watch the Secret Stress Response advertising.

(VIDEO PLAYING)

P&G cosmetics is also performing well led by North America with double-digit volume growth last quarter. This follows over 20% volume growth in the June quarter. COVERGIRL US value share is up 0.5 point versus year ago. The momentum began last winter with the launches of Clump-Crusher mascara, which reached the sixth share of the mascara category after only four months in market; Outlast Nails, a premium long-lasting formula with built-in topcoat that lasts for seven days; and Lip Smoochies that are attracting younger consumers to the business.

This fall, COVERGIRL launched a new Flamed Out Capital collection of mascara, lip glosses, eye shadows and nail shades in partnership with the next Hunger Games movie, Catching Fire. This collection is targeted at women in their late teens and early 20s and is expected to attract new users to the brand.

This fall, Katy Perry joined us as our newest COVERGIRL and just last week, we started shipping COVERGIRL's new Bombshell eye collection and mascara that provides 10 times more noticeable lashes. Let's take a look at some of our COVERGIRL communication.

(VIDEO PLAYING)

Our Prestige business is now over $3 billion in sales and has grown at a compound annual rate of more than 10% over the past 10 years. Our Prestige portfolio includes SK-II skincare, a recent entry into the $1 Billion Brand Club and a full portfolio of male and female luxury and fashion fragrances, including Dolce & Gabanna, Gucci, LACOSTE and Hugo Boss, the world's leading male fragrance.

We're continuing a steady drumbeat of innovation across the Prestige lineup, including the recent introductions of Gucci Made to Measure and Dolce and Gabbana Pour Femme Intense. Salon Professionals has been steadily improving sales, which were flat last quarter. A primary driver for this momentum is breakthrough innovation like ILLUMINA hair color, Nioxin and Wella Color.id, which just started shipping a few weeks ago. These new products are growing our existing business and are driving new distribution to more salons.

Finally, many parts of our hair care business are doing very well. Head & Shoulders is the largest shampoo brand in the world. Sales have grown at a compound annual rate of nearly 8% over the past three years. The brand has grown global value share for each of the last nine years.

On Pantene, recent product packaging and commercial innovations have driven strong growth in Japan, Latin America and Central and Eastern Europe, Middle East and Africa. Pantene shipments were up double digits in Latin America and Central and Eastern Middle East and Africa for the September quarter. Let's watch a piece of the Brazil expert launch copy.

(VIDEO PLAYING)

The progress in these parts of the business has been partially offset by challenges on two big brands – Pantene and Olay – in a few big markets. The biggest opportunities on Pantene are in North America and on Olay are in North America and China. Both of these brands are still the equity leaders in their respective categories, providing a strong foundation to build upon.

Making major changes and momentum of businesses this size though doesn't happen overnight. Last January, we began converting all of the US Pantene-base product line positioning back to health-based hair benefits, consistent with Pantene's leading brand equity. As we make the changes, we are ensuring that the benefits are clearly and consistently communicated with strong claims on package and advertising, online and at the shelf.

Since making these interventions, absolute value share has stabilized. This month, we began making additional product packaging and marketing improvements across the Pantene lineup that will deliver healthier hair with every wash. These are two steps on a journey to holistically improve Pantene's consumer proposition and return the brand to market share growth.

We are building holistic plans to address Olay's overall brand architecture and execution, including consumer benefit segmentation, product formulation, packaging and communication. We've also made investments to improve supply chain capability. In the areas where we have made interventions, we're beginning to see positive results. Earlier this calendar year, we launched Olay Fresh Effects in the US. This product line is targeted at younger consumers interested in more than anti-aging benefits and it filled a gap in the mid-tier of our portfolio. Distribution on Fresh Effects is ahead of target and over 80% of consumers trying Fresh Effects are non-Olay users.

In China, we're working across product lines, price tiers and benefit segments to clarify and improve our consumer position. We recently launched upgrades to the Olay Natural White line. And early next year, we will be introducing Olay Complexion Correction or CC Cream. We will be launching new Olay innovations as they are ready for market. Each launch is another step toward improving the strength of the brand.

So several of our beauty segments are doing quite well. We are pleased with our results in personal cleansing, deodorants and cosmetics and with the positive momentum in our Prestige and Salon Professional businesses. In addition to the innovations that I've shared today, we have additional plan elements that will be announced over the next month or so, including new items and new ingredients in US skincare and US hair care. We are making progress on Pantene and Olay, but it will take some time to return these brands to market share growth.

I'll next move to healthcare. P&G Healthcare, products include Vicks, Metamucil, Pepto-Bismol, Prilosec, Clearblue and Align. They also include Oral-B and Crest and our vitamins, minerals and supplements businesses. We are focused on growing in this space, expanding into new markets, new brands and new categories. Over the last several years, we have been globalizing our toothpaste business under the Oral-B brand. Since 2009, we've launched Oral-B toothpaste in 40 countries across four regions. The most recent were our expansion into India in June and Hong Kong last quarter.

In wave one markets like Belgium and the Netherlands, toothpaste value share is in the teens. In Latin America, where we now sell toothpaste in all major markets, growth is very strong. Last quarter, toothpaste sales for the region were up more than 40% led by Brazil growing over 50%.

We are currently expanding Vicks, one of our $1 billion brands both geographically and into new categories and treatment areas. In mid-2012, Vicks launched into Russia, Poland, Czech Republic and Hungary and it was introduced into the Ukraine earlier this year. Just recently, we began to expand Vicks into new countries in Latin America, launching in Peru in July. A little over a year ago, we introduced Vicks ZzzQuil in the US entering the sleep aids category. Within the first six weeks of launch, ZzzQuil achieve the number one position in dollar and unit sales for brand of sleep aids. ZzzQuil has grown to nearly 20% value share in the US and we expanded it into Canada earlier this calendar year.

This summer, we launched NyQuil and DayQuil Severe in the US. These premium versions of NyQuil and DayQuil provide maximum strength cold and flu relief through an added nasal decongestant in NyQuil and a chest expectorant in DayQuil. No other OTC medicine provides stronger cold or flu relief.

Metamucil is another brand that has significant opportunities for growth. Metamucil is the only leading fiber supplement brand that contains 100% natural psyllium fiber. Not only does Metamucil help maintain digestive balance, it's also indicated to help maintain healthy blood sugar levels and it helps lower cholesterol. We are just beginning to educate consumers on these additional multi-health benefits. We are working on ways to make taking Metamucil even easier. Currently, we sell the product in powder and capsule form and have two easily portable options, multigrain wafers and single-dose packets. Metamucil is currently sold in only 12 countries with close to 90% of sales in three countries. So there is geographic expansion upside as well.

The PGT Healthcare joint venture was formed in 2011 when P&G teamed up with Teva Pharmaceuticals. This is an exciting partnership, which brings together Teva's industry-leading capabilities in product development, drug registration, manufacturing and pharmacy channel sales with P&G's core strengths in consumer and shopper understanding, brand building and go-to-market capabilities in mass grocery and high-frequency stores. The joint venture includes all of P&G personal healthcare business outside of North America and all of the over-the-counter business of Teva.

PGT Healthcare has given P&G access to many new over-the-counter brands. For example, Ratiopharm is a very large OTC brand sold in over 30 countries with more than 700 products available. Since the creation of the JV, Ratiopharm sales have grown over 25% while simultaneously expanding operating margins by over 15 points. This growth has been driven by a combination of pricing, improved go-to-market fundamentals and enhanced marketing plans. Expansion into faster growth markets, pricing across P&G and Teva brands like Ratiopharm, and improvements in sales capabilities and marketing have served a significantly accelerate the growth of PGT since the start up of the joint venture. Calendar year to date, the business is growing sales in the mid-teens.

We've also entered into new fast-growing categories like vitamins, minerals and supplements or VMS. The VMS category is the largest in the over-the-counter industry at about $85 billion in sales and it is the largest and fastest-growing segment in consumer healthcare. We compete in vitamins, minerals and supplements with two brands and as we announced yesterday, we will soon be competing with a third brand.

Through the PGT Healthcare joint venture, we gained access to vitamins, which are currently sold in Poland and the Czech Republic and will be expanding into Italy and Holland this January. This brand is focused on children from babies to preteens and on expectant and nursing mothers.

In June 2012, we acquired New Chapter, a leading brand in the VMS category within the specialty whole foods and natural channels. New Chapter has strong brand equity and a very broad portfolio of premium products that have achieved strong consumer ratings. Since the acquisition, sales have exceeded expectations.

Finally, as you may have heard, we just announced that PGT Healthcare is forming a partnership with Swisse Wellness. Swisse Wellness is the fastest-growing over-the-counter company in the world over the last five years. Swisse is the leader in the vitamins, minerals and supplements market in Australia, one of the most developed VMS markets in the world. Swisse Wellness is currently available in Australia, New Zealand and the United States. The new partnership will focus on expanding Swisse Wellness vitamins and supplements into Europe and Asia over the next few years with plans to eventually expand it around the world. We've made good progress on healthcare over the past few years and we are encouraged by the opportunities ahead.

In closing, we expect 2014 to be another stepping-stone to P&G's long-term growth objectives. We will make choiceful investments in core businesses, in the most promising developing markets and on our biggest brand and product innovation opportunities. We will aggressively drive productivity, cost savings and cash productivity. We are cautious given some of the headwinds we've mentioned, but are also encouraged by business trends in several important markets and are confident in the clarity and the focus of our direction. Now I'd be happy to take a few questions. Dara, would you like to start?

Question-and-Answer Session

Dara Mohsenian – Morgan Stanley

I need some DayQuil. So, Jon, I was hoping you could review if you're happy with your portfolio here as you look out over the next couple of years, if there might be some divestitures and which businesses maybe aren't as strong a fit with the core focus that you've talked about?

And then also on the other hand from an acquisition standpoint, is that an area of focus and particularly on the beauty side, do you think you have the right portfolio to win or are there some holes there you could fill in over time?

Jon Moeller

So first, from a divestiture standpoint, as most of you know, we manage our portfolio in a fairly disciplined fashion. We review its potential to create value with the senior management, with the Board once a year and we act on those reviews. We've traditionally gotten out of – I mean, over the last five years, we exited pharmaceuticals, we exited snacks, we exited coffee, we've exited water filtration, we exited bleach in many parts the world. So that's something that I would expect to continue and obviously, we are not going to name names at this point.

But the decision criteria though is very simple and it comes down to our ability to create value through leveraging our core capabilities as a company. And historically over time where businesses leverage those core capabilities, we do very well and sustainably creating value for both consumers and shareowners, but where additional capabilities are needed, we struggle a bit. So we will be looking to focus resources on businesses that play to our strength.

In terms of acquisition, we will continue to look for small portfolio fill-ins both from an acquisition and licensing standpoint, obviously the Swisse Wellness opportunity that I talked about, the PG Teva joint venture, which I mentioned, are examples. Those aren't acquisitions, but they're either joint venture creations or licenses. And in general, I don't think we need – we're not dependent on acquisition to grow our business. I really believe that this Company has more organic growth opportunities in front of it than it has in the past 175 years of its existence. There are tons of opportunities. Almost the entirety of our $33 billion developing market business was built through expansion of our brands as opposed to acquiring brands.

So we will be selective, we will be targeted, we will be opportunistic, but we are going to do most of our growing organically. Are there questions? I like this group.

Dara Mohsenian – Morgan Stanley

So Jon, in terms of the earnings growth outlook for the back half of the year, you mentioned some of the reasons why you expect to ramp up, but you are expecting on a currency-neutral basis to see mid to high teens growth in the back half of the year. Can you talk about what drives your comfort level behind that and particularly from a margin standpoint what's driving the leverage from the top line down to the bottom line?

Jon Moeller

So if you look at the quarter we just completed and one of the slides I showed, we are growing – we grew core earnings per share on a currency neutral basis about 8%. So the step-up from – call it that level of 8% to low doubles to mid-teens is really driven by two things. One is – well, three things. First is, in the last two quarters, we've had significant cost of goods sold impact from a negative standpoint due to the startup of new manufacturing facilities as we work to localize our supply chain around the world. We will continue to incur those costs, but they will annualize as we get into the back half.

The second piece is that our cost savings program, whether it's cost of goods, whether its overheads or whether it's advertising, will build on itself as we go through the fiscal year.

And then the third is that frankly some of the pricing that we are going to need to take to recover currency impacts in many parts of the developing world will also be back half loaded.

Last, I mentioned in the second quarter of this year there is a gain in the base period from the sale of our bleach business and that will be something that we will not have to anniversary in the second half of the year. So those are the major drivers.

Unidentified Speaker

I have two quick questions. One is what do you see as the near-term and long-term growth of the fragrance industry, I guess the high-end Prestige fragrances that you (inaudible) for the category? And then second, what are you doing specifically in China to address transforming Olay or improving that brand?

Jon Moeller

We like the fragrance business. Primarily the Prestige end and the fashion-oriented end of that business. We tend not to play in the lower end of the fragrance business. We believe that as the beauty market grows in many parts of the developing world, particularly Asia, Latin America, also Russia, that there's significant opportunity for us there. Our track record on growth and fragrance has been a strong one. Unlike some competitors in the market, our margin progress has also been very strong on Prestige and on fragrance. So it's a business that we will continue to fuel.

In terms of Olay in China, I pointed out a couple things we are doing there to further improve the brand architecture – the targeting of products to individual consumer segments and a communication that helps us target those segments. I also mentioned that both in North America and China, the progress that we are going to be making on Olay will require some patience. It will not turn overnight. The same with Pantene in North America.

Unidentified Speaker

[INDISCERNIBLE]

Jon Moeller

In the markets where we compete currently, it's growing and has grown.

Unidentified Speaker

Hi, just a question on pricing power, especially in Europe. Obviously talking with a European hat on, it's obvious that quite a few countries are facing deflation now. So just, wanted to have a feel for how the conversations with the retailers are going and then if you can overlay that with comments on the competitive environment please?

Jon Moeller

Well, first of all, from a same-store sales standpoint, retailers generally want to obviously grow sales. So they're interested in doing that in a way that is value-accretive for consumers. So it comes down to value – the broad definition of value, pricing is an important part of that, but also product performance, aesthetic, consumer experience with that product. And when we can offer a superior value equation, the retailers generally view that as an opportunity to build the category, build same-store sales and they are supportive.

We can't just take pricing in a value-dilutive manner. It needs to be with holistic value creation. And the consumer response to that same holistic approach to value creation has been positive whether it's on Gillette ProGlide, the premium priced razor, whether it's on Ariel Pods, we have not had – we've been very successful bringing improved holistic value to consumers and increasing sales. I think my time is up. Great. Thanks, everybody.

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