Well, it might be fair to say that Warren Buffett saw the earnings disappointment from Procter & Gamble (PG) coming. In an interview with Becky Quick of CNBC last month, Buffett offered this cryptic commentary about one of Berkshire Hathaway's (BRK.B) largest fund holdings, Procter & Gamble:
"BECKY: Recently, I think Procter & Gamble caught- its full-year outlook talked about some disappointing market conditions in some arenas.
BECKY: What did you think of that?
BUFFETT: Well, I think they've found that they're having problems, you know, raising prices in certain areas and ...
BUFFETT: No, they have learned- and I'm privy to know special information on this but ...
BUFFETT: ... but clearly they have found they did not have the pricing flexibility with some items that they thought they had.
BECKY: Is that- I mean, it may be surprising when you're talking about how consumers are feeling a lot better. I guess consumers have pared back the same way that businesses have.
BUFFETT: It depends on the item, though, to some extent.
BUFFETT: But I- but consumers are always looking for values, I mean...
BUFFETT: ... you know, it- you want to be with a low-cost operator. Now, that's an advantage that Wal-Mart (WMT) has, that's an advantage a Costco (COST) has, and you can look throughout the field. People that are low-cost operators have an advantage. And P&G has been selling higher-end products generally compared to private labels that were available.
BECKY: Mm-hmm. It doesn't change your opinion as a shareholder, I take it. You're a long-term holder.
BUFFETT: Well, we've been a long-term holder.
BECKY: That sounds less ...
BUFFETT: It sounds a little weaselly, doesn't it?
BECKY: It does- it does sound a little weaselly. Are you selling?
BUFFETT: Yeah, well, it's a little weaselly.
BECKY: So are you selling or ...
BUFFETT: I'll just say that we've been a long-term holder.
BECKY: We'll leave it at that.
BUFFETT: And that I'm being weaselly.
Well, that Buffett exchange was certainly something, wasn't it? Buffett's quiet reduction of Procter & Gamble shares has been going on for a couple years. In 2007, Berkshire Hathaway (BRK.A) owned 101 million shares of P&G. By 2008, he reduced his stake to 91 million shares. In 2009, he quietly trimmed Berkshire's stake to 83 million shares. And in 2010 and 2011, Buffett kept the Berkshire stake in Procter & Gamble steady at 72 million.
Buffett's ownership stake of Procter & Gamble barely gets mentioned in the annual letter to shareholders of Berkshire Hathaway, and it's worth keeping in mind that Buffett didn't so much buy Procter & Gamble as held it-Buffett loaded up on shares of Gillette, and then continued to hold the shares after the Procter & Gamble buyout. Now, Buffett only owns 70% of the P&G stake that was in Berkshire's 2007 stock portfolio.
Given Buffett's cagey comments in the interview, it seems realistic to assume that next year's letter will reveal fewer P&G shares in the portfolio than the last reported stake of 72 million shares. This is interesting because it suggests that Buffett is selling P&G because he does not like the future prospects for the company, as opposed to selling the blue chip to raise cash for another purchase. After all, Berkshire Hathaway has around $30 billion in cash and cash equivalents which makes it unlikely that he is reluctantly selling P&G in the pursuit of an irresistible deal.
Personally, I was struck by the two lines I'm privy to know special information on this and Well, we've been a long-term shareholder … that sounds a little weaselly, doesn't it? Although Buffett did mention his concern about P&G's lack of pricing flexibility, it is difficult to gauge the reasons that might have led Buffett to trim his P&G stake further. Is it the fact that P&G is getting hit adversely by exchange rates? Is it the slowdown in China, the restriction on sales in Brazil, and the mandatory price cuts in Venezuela, coupled with a hobbling Europe? Is it the rising commodity prices, the loss of market share to competitors like Unilever (UL) and Colgate-Palmolive (CL), and the inept management led by Bob McDonald? My guess would be the third option.
It seems that Procter & Gamble might have a rough couple of years ahead of it in the earnings growth department. Of course, there are some good news on the turnaround front-P&G is planning to reduce costs by $10 billion, and the company does maintain over a dozen billion dollar brands in its portfolio. Let's not forget, P&G has 21 different brands that generate over a billion dollar in sales: Always, Ariel, Bounty, Braun, Charmin, Crest, Dawn, Downy, Duracell, Fusion, Gain, Gillette, Head & Shoulders, Iams, Mach 3, Olay, Oral B, Pampers, Pantene, Tide, and Wella. And the company also has 19 $500 million brands like Swiffer, Febreze, Cover Girl, and Ace. So let's not sell the underlying assets short. It seems like P&G's worst case scenario is a couple years of 2-5% earnings growth and dividend increases if the ship does not turn around, and the company could do significantly better if the $10 billion cost reductions, renewed focus on developed markets like the USA, and competitive pricing initiatives come to fruition. It's nice knowing that a realistic worst case scenario is anemic earnings and dividend growth instead of dividend cuts, severe earnings deterioration, or bankruptcy.