P&G's Brand Divestitures Should Unlock Greater Value


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Procter & Gamble ( PG ) is the world's largest consumer goods company, with almost 200 brands in its portfolio. And it competes with other global consumer goods companies such as Unilever ( UL ) and Colgate-Palmolive ( CL ). The company has a market capitalization of approximately $224 billion and annual revenues of about $83 billion in fiscal year 2014, marginally higher than sales from fiscal year 2013. Operating profit margins for FY14 stood 1 percentage point higher over FY13, at 18.4%. Similarly, net earnings margin (from continuing operations) expanded 40 basis points to 14.1% in FY14.

P&G classifies its extensive brand portfolio across five broad product categories, namely: 1) Beauty; 2) Grooming; 3) Health Care; 4) Fabric Care and Home Care; and, 5) Baby, Feminine & Family Care. In this note, we talk about key trends that could impact P&G's business briefly.

We currently have a $70 price estimate for P&G's stock , about 16% lower than its current market price.

See our complete analysis of Procter & Gamble

P&G Plans to Trim Portfolio as Consumer Spending Starts Recovery

The sheer size of its brand portfolio has been an issue for P&G in terms of sales growth. The company's top 70 t0 80 brands make up about 90% of net sales and over 95% of net profit, with the remaining 120 to 130 brands contributing a minimalistic 10% to net sales for the company. However, declining consumer spending in developed markets after the economic crash, combined with inflationary pressures in emerging economies created a weak sales environment globally for consumer goods companies, resulting in a greater emphasis on bottom line through cost savings. The higher emphasis on its earnings growth has led to a deferral in shedding underperforming brands for P&G.

In this regard, P&G has planned an ambitious five-year plan lasting until fiscal year 2016 and expects to cumulatively save about $10 billion in cost of goods sold, marketing expenses and non-manufacturing related overhead. It saved $1.2 billion in cost of goods sold in FY2013 and delivered on its earlier guidance of saving $1.6 billion in cost of goods sold in FY2014. However, more recently, the company announced its intention to shed close to 100 brands that have minimal contributions to P&G's top line in a bid to accelerate sales growth in the improving global economy.

This strategy should bode well for P&G's sales, with the savings from discontinuing underperforming brands being reinvested into expanding operations in high growth markets. P&G derived about 43% of FY14 sales from Asia, Central and Eastern Europe, the Middle East, Africa and Latin America combined. Comparatively, the contribution from emerging and frontier markets is much higher for its competitors, such as Unilever and Colgate Palmolive. Despite the recent currency depreciation in emerging economies that has created inflationary pricing pressures on consumers, uptake of consumer goods and products remains higher in emerging markets compared to developed economies and should attract P&G into enhancing its position in these markets.

Portfolio and Manufacturing Streamlining Could Improve Sales and Margin Growth

As a percentage of revenues, P&G generates about 32% of its sales from the Fabric and Home Care segment, 25% from the Baby, Feminine and Family care segment, and 24% from its Beauty segment. Grooming and Health Care segments constitute smaller revenue shares for P&G, at 10% and 9%, respectively, in fiscal year 2014. The Fabric, Home and Pet Care unit is also P&G's most valuable segment, accounting for approximately 28% of overall value. Its Beauty segment comes second in the value chain, contributing about 22.5% to P&G's business.

In Q3FY14, the company completed its sale of the Pet Care business unit to Mars Incorporated for $2.9 billion. P&G's CEO, AF Lafley, stated that exiting the pet care business was an important part of the company's overall strategy to focus its product portfolio on the core businesses that provide the most value for consumers and shareholders. We are presently adjusting our P&G model to reflect the sale of its pet care business. However, the divestiture should have marginal impact on the divisional valuation, given that the pet care sales in fiscal year 2014 accounted for a meager 0.9% of overall revenues.

Additionally, the company plans to combine business units and redesign its supply chain system so as to save between $200-$300 million annually over three to four years. P&G plans to reduce its manufacturing footprint from many, single product plants into fewer, multi-category plants that have common manufacturing platforms. Last fiscal year, P&G's unit volume sales increased 3%, driven by mid-single-digit increases in volumes of its two largest divisions.Unit volumes increased low single digits for Grooming and Health Care segments, while Beauty products had negligible growth in volume sales.

Shedding underperforming brands, streamlining manufacturing operations, and innovating further with its billion dollar brands across business units should take P&G growth higher going forward. Innovation has been a core part of Procter & Gamble's business strategy, and this has allowed it to become the market leader in consumer products. Seven of the company's products made it to leading market research company IRI's list of top 10 non-food U.S. consumer product innovations in 2013. P&G's recent launches in fabric care, such as Tide Pods, Ariel Pods and Gain Flings, are gaining traction in the developed markets and should be able to lift a nimbler P&G higher post the brand divestitures.

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