What’s wrong in Cincinnati?
It’s been one year since A.G. Lafley rejoined Procter & Gamble—swooping in to replace Bob McDonald—four years after Lafley retired from the job.
Lafley famously helped turn around the company when he joined in 2000 by focusing on innovation and later buying Gillette, and his return to the helm was expected to restore growth at the world’s largest consumer products company.
A year later, investors are still waiting.
The maker of Pampers diapers, Crest toothpaste and Tide detergent, just reported earnings excluding items of 95 cents per share, compared with Wall Street’s prediction of 91 cents a share, according to a consensus estimate from Thomson Reuters. It also announced a 37 percent jump in quarterly profits, owing in part to cost cuts.
While profits have been exceeding expectations, due largely to cost-cutting efforts, revenue has missed the mark the last three quarters, including in this latest quarter.
Investors welcomed Friday’s news, largely because of plans to sell or discontinue products, and sent shares up more than 3 percent in trading. But prior to earnings, shares were down 5 percent this year, underperforming both the Dow Jones Industrial Average and the S&P 500 Household Product Index. Over the last year, it’s the Dow’s second-worst performer.
Many are asking whether P&G’s troubles are theirs alone or challenges the industry is facing. The answer is it’s both.
There is no question consumer products companies are facing major headwinds, including a sluggish recovery in consumer spending in developed markets like the U.S. and uncertainty on growth in emerging markets, along with sharp swings in foreign exchange rates, which cut into overseas earnings.
Earnings in the sector have been disappointing across the board. Thursday, L’Oreal, the world’s largest cosmetics company, missed estimates saying it was “held back by a sluggish American market.” Colgate-Palmolive sales missed its estimates, with North American sales up only 1 percent in the quarter. Kimberly-Clark, which makes Huggies and Kleenex, cut its outlook last week.
Unilever, the company behind Lipton tea, Dove soap, and Ben &Jerry’s ice cream, missed sales estimates as well. CEO Paul Polman said, “We have experienced a further slowdown in the emerging countries, while developed markets are not yet picking up.”
Clearly, the industry is struggling and has yet to participate in the broader economic and recovery in consumer spending.
Something else wrong?
Despite the tough macro environment, analysts who cover P&G say, many of the problems the company is facing are self-inflicted.
Since Lafley’s return, none of the main categories—baby, feminine & family care; global beauty; global fabric and home care; and global health and grooming—are firing on all cylinders.
He has pursued deep cost cuts to boost productivity and profits, cut a $2.9 billion deal to sell off pet food business, launched a review of factory operations and operations and focused on innovation, rolling out new products like Gillette’s Fusion ProGlide razor. And he is still pursuing a sale of the pet-care business in Europe.
Now, the company says it will keep only 70 to 80 brands and divest or discontinue the rest—some 90 to 100 brands—over the next 12 to 24 months to help narrow its focus and cut even more costs.
“After a year in, many things internally have changed, but the results haven’t,” said Ali Dibadj, an analyst at Sanford C. Bernstein. “Changing a big company is slow, but this feels like something else might be wrong.”
Looking back at last year, Lafley “could have underestimated the toughness of the global consumer environment, reinvestment needed to halt share losses where consumers have turned to value, how much better competitors have become and how quickly the development of retail is undermining the advantage scale provides when distributing in China, and Russia,” said Consumer Edge Research analysts in a note published ahead of earnings.
Analysts said there are also fundamental issues that make it harder for P&G to grow in this environment, including the company’s lack of local manufacturing presence, which has saved competitors like Unilever money on labor and production costs and has pressured P&G’s margins. Some products sold in Brazil, for instance, are made in Europe, according to analysts.
Another issue: The corporate structure where decisions are made, and business is reported, is done so by category—i.e. beauty or grooming—instead of geographically focused by region, which is how Colgate operates. P&G’s structure may result in a misunderstanding of local consumer markets and tastes and an inability to be nimble regarding changes and decisions on brands and execution, particularly important for the localized beauty market.
The company also might have to rethink pricing.
“I think P&G is at too high of a price in categories that are becoming commoditized. Do you really care about which laundry detergent you use to pay 2x for Tide? Also, the categories themselves are slowing because of that (i.e., trading down) and thus competition is on the rise,” Dibadj said.
John Faucher, who covers the stock at JPMorgan, said P&G has room to lower prices, especially as the brands have lost their premium value to competitors over the years, cut costs further, and innovate with new products.
But there’s been market chatter about P&G breaking up and spinning off the individual businesses to unlock value and bring a sharper focus on execution and growth for each category.
Nik Modi of RBC Capital Markets said earlier this week, that he wants to know specifically how P&G plans to cope with troubles in the beauty business, and “if they can’t, I would like them to address whether they would ever spin off the business.”
Despite the challenges and the to-do list, Wall Street analysts are fairly optimistic.
Faucher has a “buy” rating on the basis that “the concerns on top line and gross margins have weighed on the stock, in our view. We see upside versus the group as margin and EPS performance improves in 2015.”
Beyond steering the company back to growth, the other task for Lafley in taking the top job was to choose a successor, as he had never intended on staying for the long run.
So far, no hints of where the company or he is in the selection process, but perhaps P&G should break with its long-standing and deeply imbedded practice of hiring within, to bring in some fresh ideas. Because the task at hand is steering a diversified, global juggernaut—121,000 employees large, that traces its roots back to 1837—back to growth.
“If this legendary CEO can’t fix the business over the next year, I think it means it is unfixable in its current form and the problems need to broken up into smaller ones…i.e., a break up,” Dibadj said.