Shrink to Grow Continues… But Alone, the Growth Will Be Temporary
Procter & Gamble (NYSE:PG) has continued to shed its less profitable brands and seeks to cut another $10 billion in costs. The goal is to cut those brands, processes, and personnel that do not significantly contribute to sales. While this can be done to some degree, I have my reservations that all of these lofty targets can be met. While I will not say that PG's strategy has failed if the goal is to simply increase EPS, my reservations agree with fellow contributor No Guilt, who commented it is dead money outside the dividend.
For those looking at this strategy, the results thus far have been increases in EPS while decreases in revenues - what you would expect from higher margin sales, but fewer brands being sold. But with 1-2% organic growth in sales now becoming the standard, the company faces issues of chopping itself too lean while creating nothing new. In other words, the growth will come in EPS, but will hit a brick wall, without innovation or a spinoff restructuring. In addition, many of these cuts are likely to hit design and production teams that have longevity with PG in creating some of its best products. It is not a solid way to attract future talent in a company known for long tenure, and cutting only can go on for so long… No pun intended to the Brexit, but it is a "penny smart, pound foolish" way of doing business.
A great example of how this process of just discarding brands often lacks value is Unilever (NYSE:UL), which cut hundreds of brands in the early 2000s only to not outperform PG at all. In fact, PG beat UL until around 2012 as seen below:
Courtesy Google Finance
But then UL has outperformed PG over the past several years - much of this can be attributed to its change in the way it has restructured its brands and has led to strong consumer staples growth in 5-6% range (more on this in the next section). So it brings me to question PG's end state, for which I see two positive choices that PG can make to bring shareholders value.
One Company's Lead is Another's Gold
The first solution is small acquisitions that fill gaps or actually looking to develop truly new and innovative products that complement current lines. Bain and Company has a great piece on shrinking to grow, and its bottom line was that companies get rid of the "trash" and at the same time acquired other companies' "trash." For example, Folgers Coffee to J.M. Smucker (NYSE:SJM) and Pringles to Kellogg (NYSE:K). But this goes back to the idea of complements and substitutes - companies discard brands that do not meet their business model and acquire those that do. I labeled it as filling the gap, and what Bain shows best is that companies cannot really just cut and expect growth; they have to either acquire or expand product lines through true innovation (not a chill strip on a razor). Going back to UL, since 2008, it has remained at nearly a 1:1 ratio of shedding and acquiring brands - thus it has cut products that did not fit its model and filled gaps that complement its focus.
Breaking Up Is Hard to Do
I have asked on a number of SA articles where the growth will come from, and since November, financial media have been rife with breakup ideas for PG (here, here, and here). This would be PG's second way to actually unlock value, and really only one contributor responded with a solid response - Willow Street Investments:
While PG has not ruled it out, and I remain skeptical of anything happening in the spinoff/breakup lanes, there is historical merit to this idea. A JPMorgan analysis has shown great merit to this strategy. The bottom line is that firms doing a spinoff typically outperform in both the long term and short term. And I do have to agree with Willow in that a smaller company can do much better with innovation and performance.
But - and here is the but, can PG do it? Is the culture going to allow for it to occur? I have my doubts just based on leadership that is too ingrained in its enduring business, the same leadership that has given ambiguous and "tap-dancing" answers to even some of the most direct analyst questions during conference calls. They just don't promote confidence when the plan sounds too much like an "if we build it, they will come" solution. And if PG can't break up, then investors are left either awaiting an activist investor or looking back at the first solution of acquisition.
It's a Bond if You Buy Now
The bottom line is that buying right here, under the current cut-to-grow strategy, you are buying a bond yielding more than 3.25%. The company is like a rock - it's likely to be a good defensive play in a downturn, but it also is unlikely to float higher unless something meaningful occurs. If you are looking for a consumer staple company with growth, PG is likely not your bag unless it announces changes to its current strategy. EPS is going to improve, but it will hit a wall just as its recent dividend increases have done. So if you need a relatively safe yield, take a gander; but I am holding and waiting for a yield closer to 4% for a better margin of safety.
As always, I appreciate your time in reading, especially to my followers. If you would like to follow me, just click the button near the top next to my name. Best of luck to all.
Additional Disclaimer: Each investor has their own goals and needs; in these regards, individual due diligence is a necessity prior to making any investing transaction. I hold PG from purchases made in 2012-2013, and have since been allowing the dividends to reinvest. I plan to re-initiate purchases if the yield nears 4% in the near term.
Disclosure: I am/we are long PG, K, SJM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.