Despite the shared obsession between corporate executives and Wall Street over cost-cutting, costs are not necessarily Procter & Gamble's (PG) biggest problem today. Instead, the company may be paying the price for getting too aggressive on price and too lackadaisical on product innovation. With rivals like Unilever (UL) and Colgate (CL) showing more in-store momentum, P&G investors may want to prepare themselves for a few more quarters of unimpressive earnings reports.
Sluggish Growth Is Still Growth
Although Procter & Gamble has certainly lagged the likes of Unilever, Henkel, and Reckitt-Benckiser lately, the company is at least still showing organic growth. Overall revenue grew 2% in the fiscal third quarter, while organic revenue growth came in at 3% with a 5% boost coming from pricing action. Baby and Family Care was the best grower (6%), while the other businesses logged 2% organic growth.
Profitability was not all that solid, though. Gross margin declined more than a point and adjusted operating income rose less than 1% (while reported operating income fell 11%).
Is It Share Or Price?
P&G management has been blaming a lack of innovation for its recent share declines (backed up by Nielsen data), and they may have a point. P&G was a little sluggish in following rivals like Church & Dwight (CHD) and Henkel with new single-serving laundry packaging, but I suspect this is only part of the problem.
P&G has been a lot more aggressive with price in developing markets, and has become one of the most active/aggressive companies in terms of price-based promotion. With more and more consumers turning to store brands or going down-market to stretch their money a little further, aggressive pricing may be driving P&G customers over to Unilever, Clorox, and the like.
Streamlining Makes Sense, But Cost Cuts May Be Unrealistic
Investors may also want to reexamine management's bold targets for cost cutting over the next four years. Management has targeted $10 billion in cuts, comprised of reduced marketing, COGS, and headcount expense.
This is a bold goal, particularly for a company that already scores pretty well in terms of its relative margins and profitability. Building more plants in markets like China, Brazil, and Eastern Europe will help, but that initial enthusiasm that investors expressed for the cost cuts might have to be tempered with what is really achievable. Moreover, investors may want to consider the case of Kellogg (K) - a company that cut too deeply and has had to backtrack at some cost to profits and operating efficiency.
Still, I'll give credit where credit is due. P&G managed to salvage a good deal for Pringles after the original agreement with Diamond Foods (DMND) fell apart. Moreover, selling PUR to Helen Of Troy (HELE) was a good move on balance - I happen to think there's growth potential in that business, but P&G had been under-investing in that brand and losing share to Clorox in the interim.
The Bottom Line
I know that any criticism of a company like P&G is going to be answered by people pointing to the dividend and claiming that they're happy to take a long-term view with a company that has been a leading player for many decades. Fair enough.
I just don't happen to see all that much value in these shares. P&G doesn't have an especially solid growth story in emerging markets yet, and may be pricing themselves out of developed markets, while focusing a lot of attention on costs while price may be the bigger issue. Even with the expectation that the next ten years see more free cash flow growth than the past ten, these shares just don't look cheap enough to interest me today.