Procter & Gamble (PG) board has reaffirmed its support for CEO Robert McDonald a week after activist investor William Ackman’s investment firm Pershing Square Capital Management purchased $1.8 billion worth stake in the company. Ackman’s intention behind the investment is to put pressure on P&G management to speed up restructuring and cost cuts and a possible divestiture of brands like Duracell and Iams to increase shareholder return. The stock has gained more than 6% since the news of Ackman’s stake purchase in P&G surfaced.
P&G hit rough waters after losing market share to competitors in several of its core markets this year as its attempt to manage high costs through short-term price increases backfired. In June, P&G disclosed that it expects its Q4 sales to decline by 1%-2%, in contrast to 1%-2% sales growth expected previously, fueling further investor pessimism. The company has trimmed its profit forecasts three times this fiscal year because of slowing sales growth in Europe and the U.S., rising commodity costs, unfavorable foreign-exchange rates, and price reductions.
The operating margins have also suffered a gradual and steep decline over the last three years amid high-input commodity prices, causing its stock price to stagnate in the $60 range for years. In contrast, its major competitors like Unilever, Colgate-Palmolive, and Kimberly-Clark have performed much better during the same period amid similar market challenges.
Ackman Seeks at Least 20%-30% Return
Ackman is believed to be seeking around 20% to 30% returns from his investment in P&G. Assuming he bought his $1.8 billion stake for around $61 per share, these returns would require P&G’s stock price to climb to $73 to $79. Even though Ackman’s current stake is barely 1% of P&G’s market capitalization, it has created pressure on the management to accelerate its cost-cutting and restructuring measures that have so far been slow.
Any more bad news or slow recovery might galvanize more support for Ackman from an already disappointed and impatient shareholder community. Anticipating this, P&G is also likely to engage PR firms and banks to brace up for upcoming situations.
Our current P&G price estimate of $66 assumes moderate improvement in operating margins assuming the consumer giant can absorb commodity prices through cost cuts and improve savings without resorting to price increases. Market share of fast moving consumer goods are highly sensitive to prices and any attempt to recover lost margins through higher pricing immediately leads to consumers trading down to cheaper alternatives and, often, permanent loss of market share. P&G’s current turnaround strategy includes consolidation of its market share in top 40 businesses and top 10 developing markets along with a $10 billion productivity program.
Asset Sales on the Cards?
Growing pressure on P&G’s management to improve returns is also likely to attract attention toward underperforming businesses and assets, such as possible divestiture of non-core brands like Duracell, Braun, and Iams to unlock more value and improve focus on core personal care and home care categories. Duracell battery and Iams pet food units are internally considered businesses requiring innovation to justify keeping them. P&G is known to have explored takeover interest in these businesses that could together fetch it $7 billion.
Disclosure: No positions.