Procter & Gamble Co. (NYSE:PG) is a global giant well-known for its banded consumer packaged goods, and has been making some organizational changes since the beginning of fiscal year 2014. The company has on-the-ground operations in 70 counties and its products are sold in more than 180 countries through various retailing mediums.
The company recorded a decline in its operating income from 2009 to 2012. This led to a negative 6.23% 3-year CAGR of the company's operating income up until 2012. The net income also fell year-over-year from 2010 to 2012 as shown in the chart below. Fiscal year 2013 was a better year for the company's income growth but revenue growth was just 0.58%. This worried investors and the company traced weaknesses beginning from its top management. As a result, the company engaged its former CEO, Mr. A.G. Lafley, back in May 2013. As a result, a $10 billion restructuring program announced by the company in February 2012 is now being executed by Mr. A.G. Lafley.
Source: Morning Star
June 2013 marks the end of the company's fiscal year 2013. Now the company is heading towards the end of Q2 fiscal 2014. Throughout my article, I will assess some of the actions and initiatives taken by company's management in order to improve its performance. The impact of current and long-term financial performance and the position of the company will also be considered with respect to the company's strategies and external environment. The positive perception of the company held by analysts, regarding steps taken by the company, can be seen as TheStreet Ratings recently ranked Procter & Gamble a buy.
To begin I will describe the company's organizational structure at the end of fiscal year 2013 which was then altered for fiscal 2014.
Organizational Structure-Segmental Analysis
At the end of Fiscal 2013
The company's organizational structure was made up of Global Business Units (GBUs), Global Operations, Global Business Services (GBS) and Corporate Functions.
Global Business Units comprise five reportable segments that are: beauty, grooming, health care, fabric care and home care and baby care and family care. Respective proportions of net sales and net earnings generated from these segments have been stated in the chart below.
Source: 10K Filings
Beauty forms the second largest contributor to the company's net sales and income for fiscal year 2013 by contributing more than 20% to the company's net sales and earnings. Billion Dollar Brands under this segment include Olay and Pantene. The beauty segment's contribution to net earnings has been declining from 24% in 2011 to 21% in 2013 while the proportion of net sales remained at 24% between 2011 and 2013.
The grooming segment was the smallest contributor to the company's net sales and net earnings for fiscal year 2013. It contributed approximately 9% to the company's net sales from 2011 to 2013 and improved its proportion of net earnings from 14% in 2011 to 16% in 2013. Billion Dollar Brands under this segment include Gillette and Mach3.
The snacks and pet care segment contributed 4% to the company's net sales and 2% to the company's net earnings in fiscal year 2011. The company divested its snacks business and sold it to the Kellogg Company (NYSE:K) in fiscal year 2012 while pet care is now a part of the fabric and home care segment. Billion Dollar Brands under this segment include Pringles.
The health care segment has Billion Dollar Bands that include Oral-B and Vicks. This segment generated 15% of the company's net sales and 17% of the company's net earnings in fiscal year 2013 which is similar to the proportion contributed in 2012.
The fabric care and home care segment contributes the largest proportion to the company's net sales and revenues. The percentage of net sales contributed by this segment increased from 30% in 2011 to 32% in 2013 while the contribution to earnings remained around 27%. Ariel, Tide and Duracell are some of its Billion Dollar Brands.
The baby care and family care segment has improved its contribution to net earnings from 17% in 2011 to 19% in 2013 while its contribution to net sales was around 20%.
Global Operations runs the Market Development Organization (MDO) and is organized geographically. The geographical regions of the company consist of operations in North America, Western Europe, Central and Eastern Europe/Middle East/Africa (CEEMEA), Latin America and Asia (comprised of Greater China, Japan) and ASEAN/Australia/India/Korea (AAIK). The following chart showcases the revenue contribution by each geographical segment.
North America is the major contributor to the company's net sales and contributed 39% to the company's net sales in fiscal year 2013 as shown in the pie chart below. Western Europe and Asia both contributed 18% to net sales. Latin America offered the smallest contribution of all the geographic regions and contributed 10% to the company's net sales in fiscal year 2013.
In terms of market maturity, developed countries are a major source of the company's net sales and contributed around 61% to net sales in fiscal year 2013. Developing economies contributed around 39%.
The Global Business Services segment is responsible for providing world-class solutions to serve customers better while the Corporate Functions segment provides services related to finance and other organizational issues.
With the aim of improving business performance, the company altered its GBU structure and the changes are to take affect the beginning of fiscal year 2014.
Fiscal Year 2014
The diagram above shows that the GBU has been organized into four industry-based sectors: global baby, feminine and family Care, global beauty, global health and grooming and global fabric and home care. As a result, feminine care will move from health care to global baby, feminine and family care. Furthermore, pet Care will be switched from fabric care and home care to global health.
As a result of this restructuring, the company can have an industry-wise and geographic focus. Through this restructuring, the company can improve its market shares in diversified industries and the geographies it operates in. The company can further penetrate existing markets while concentrating more resources into expansion opportunities. The improvement in the company's performance during the current year, as I have discussed in the beginning of this article, can be seen stemming from restructuring and other strategic decisions from top management. The company has initiated non-core restructuring spending of $67 million before tax in Q1 FY 2014.
In order to understand the current market position of the company let us have a look at the market share of its various segments and products.
Market Share and Competitive Landscape
The table below shows the global market shares of some of the company's brands company within their respective segments.
Source: 10K Filings
The chart above shows that the company maintains a majority of its market shares through its various brands over the past 3 years. Fabric care, a major contributor to the company's net sales, recorded a bit of a decline with a 25% global market share in 2012 and 2013 compared to its 30% share in 2011. On the other hand, home care captured 20% of the global market share in 2013 compared to its 15% share in 2011 and 2012.
The grooming segment contributes the least to the company's net sales so a decline in the market share of its products will have a small and immaterial impact on the overall results of the company.
Sales generated by other popular consumer good giants from the developing markets can be seen from the chart below. P&G is the market leader but has been offering a variety of products that the other competitors in the chart are not.
The chart below shows the company's foothold in the developing and developed economies. P&G has maintained a ratio of around 40% net sales from developing markets and 60% from developed. Unilever, a major competitor , is earning a majority of its net sales from developing markets rather than developed.
Now that we have examined the past and current performance and position of the company let us proceed with assessing the company's strategies to enhance its future performance and position.
First, I would like to refer to the model that the company follows in order to generate returns for its investors. The following diagram illustrates said model.
Company's Value Creation Model for Shareholders
Now, I will examine the components of this model and analyze how the company has designed its current strategies to fulfill this value creation model for its shareholders.
P&G's well-established and high-quality brands as well as its diversification assure the company's sales growth despite competition. The chart below shows the quarterly organic sales growth from Q1 FY 2013 to Q1 FY 2014.
The company has achieved an organic sales growth of 4% in Q1 FY 2014 while a guidance of a 3-4% increase has been made for full FY 2014.
The company's 50 leadership brands cumulatively account for around 90% of the company's products. Twenty-five of these 50 brands generate more than a billion dollars' worth of annual sales each. The company's strength in maintaining its market share for various brands has already been discussed above. Another factor preserving the company's sales is the fact that consumer goods are pretty inelastic when it comes to overall economic conditions of the markets thus making it a safe investment. The company previously decreased the prices of some of its products as the US as well as the global economy went through a recession. This was done to preserve sales volume but revenue growth still declined until FY 2013. Now, as the US and global economies are recovering from the recession the company will return its prices back to their previous levels and this should result in revenue growth.
Another one of the company's strength is its ability to captivate a diverse world market through three different value schemes: (NYSE:I) a universal value plan for the pure global segment,(ii) a customized value plan for the localized segment,(NASDAQ:III) and a hybrid value plan for the semi-global segments. This means customizing the company's products according to these segments and offering varied products at different geographic locations. The phenomenon has been discussed below as the term "localization".
As per disclosures by the company, its strategy will be to keep its focus upon its core markets which are led by the US and a supply chain redesign will aid in further penetrating developed markets. Growth will also be attained from expanding in the developing markets through localization. Plant expansions are in the pipeline one of which is the $100 million Greensboro expansion planned to be executed over the next three years. Such moves make more efficient use of existing facilities available.
Through Cost Savings
Although returning product prices to their previous levels will improve margins the company has also designed strategies in the form of cost-saving initiatives in order to improve its margins. The following paragraphs will provide details of the company's cost-saving initiative.
Plan and Course of Action
The cost-savings initiative announced February 2012 will be focused on reducing non-manufacturing overhead, marketing expense as well as savings in cost of goods sold. Under this initiative a $10 billion cost reduction is planned to be achieved by FY 2016. Six billion dollars of which will be saved in cost of goods sold, $1 billion saved in marketing and $3 billion saved in non-manufacturing overhead. Innovation will also be the focus while operational productivity will be enhanced for growth and value creation. The company hopes to achieve a six percent improvement in productivity and $1.4 billion as cost saving in cost of goods sold for FY 2014. Overall raw and packing material savings have also been planned. Marketing spending will increase in dollar value compared to previous years but will decrease its proportion from net sales. More reliance will be placed on digital media and low-cost locations for producing commercials. Non-manufacturing overhead is declining as a result of a decrease in non-manufacturing enrollment. These are further discussed under the heading below.
Achievements So Far
Source: Company Presentations
The table above shows that the company has successfully achieved its targets set for FY 2013. In fact, the company has attained over and above those targets. As a result, higher targets have been set for FY 2014. Approximately $1.4 billion in cost savings and a 6% improvement in manufacturing productivity are expected to be achieved in 2014 compared to the $1.2 billion cost savings and 5% manufacturing productivity targets set in 2013. Therefore, , we can expect improved margins due to improved selling prices and higher cost saving to be achieved in FY 2014.
A 6% improvement in manufacturing productivity % for FY 2014 to support efficient use of assets employed in the company has already been discussed above. The following analysis will elaborate the return on equity generated by the company.
The chart below shows the DuPont Analysis of the company in order to understand the company's asset efficiency. The analysis demonstrates the split of return on equity into the following components: net profit margin, asset turnover and financial leverage.
Source: Morning Star
The chart above shows the decline in the company's return on equity in 2012 compared to 2011. ROE declined from 18.32% in 2011 to 16.72% in 2011. This was mainly the result of a decrease in net margin and a small increase in financial leverage from 2.08 in 2011 to 2.12 in 2012. The company successfully maintained its asset turnover at 0.62 over the past three years. Net margins are improving, ROE was 17.72% in Q1 FY 2014 reflecting an improving from 17.51% in FY 2013. This is the result of the company's on-going cost-saving initiatives which are improving its margins and create higher ROE for shareholders in the future.
Cash Flow Growth
Free Cash Flow Productivity
Source: Barclays BTS Conference
The chart above targets a 90% adjusted free cash flow productivity for the company. The company has successfully achieved beyond the target in FY 2013. For Q1 FY 2014, the free cash flow productivity of the company was 43%. Free cash flow productivity is a measure of the proportion of net earnings converted to free cash flow. The free cash flow per share was 3.31 in fiscal year 2011, 3.17 in fiscal year 2012, and 3.71 in fiscal year 2013. With the achievement of the set target the company will add more value for its shareholders.
Rising Dividends and Share Repurchases
P&G has a sound history of 123 consecutive years of dividends and 57 consecutive years of dividend increases as of FY 2013. Dividend per share increased to $1.97 in fiscal year 2011, 2.29 in fiscal year 2013, and dividends of $2.33 are expected to be paid for fiscal year 2014.
Through my analysis, I have assessed the fruitfulness of the company's initiatives to create value for its shareholders. With on-going restructuring and strategies such as expansion of existing facilities and localization the company will improve its sales and margins growth and ultimately improve its cash flows. With respect to cost-saving and productivity enhancement initiatives the company is ahead of its targets. Dividend growth and share repurchases also make the stock an attractive one to invest in.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article.