Why P&G may be adrift
I believe Procter & Gamble’s neglect of its balance sheet and over-attendance to returning cash to shareholders is a result of its unambitious business model. Let’s examine P&G’s financial goals, as stated in the company’s 2012 annual report:
- “Grow organic sales 1% to 2% faster than the market grows in the categories and geographies in which we compete.”
- “Deliver core EPS growth of high single digits to low double digits.”
- “Generate free cash flow productivity of 90% or greater.”
These goals, when taken together, create a predictable performance pattern from which it is difficult to break free. If it tracks only a percent or two above market growth, (increasing annual sales 3% to 4% per company guidance), P&G will be forced to continue its cost-cutting to deliver high-single-digit earnings per share. It also must sacrifice that high free cash flow productivity of 90% to buy back shares on the open market, which helps deliver the target EPS. Is this uninspired financial strategy worth the trouble? According to the peer comparison chart above, the market seems to have punished P&G until very recently versus its competition for its formulaic, risk-averse approach to running its business.
Breakthrough potential
There is a counter-narrative to the reality of P&G’s current situation, and that story resides in the company’s product pipeline. The consumer-goods titan is widely recognized as one of the world’s most innovative corporations. For some years now, management has been promising to unleash “discontinuous innovation” to improve its sales and margins. P&G describes discontinuous innovation as “innovation that obsoletes current products and creates new categories and new brands.”
Despite the fancy nomenclature, recent innovation hasn’t really been “discontinuous.” Rather, it has centered on the basic extension of P&G’s market share. Tide Pods, introduced in 2012, are on their way to $500 million in 2013 sales. While there are indeed many groundbreaking characteristics of this product (such as the pods’ ability to dissolve completely even in a cold-water wash), its actual purpose is to extend market share of Tide, one of the company’s $25 billion brands. In the same vein, the category-leading ZzzQuil is simply a common antihistamine most of us know as Benadryl, repackaged as a sleep aid.
Discontinuous or not, as Fool contributor Demitrios Kalogeropoulos points out, some of these innovations may bear fruit in the second half of 2013. Several product wins of the magnitude of Tide Pods or ZzzQuil could propel P&G out of its cycle of mediocre results.
Wait for a trend to develop
If you’re not currently invested in Procter & Gamble, it may be prudent to wait out the next couple of quarters to see if the top-line and margin growth can continue, and if the company can gain true momentum from innovations in its product pipeline. Beyond the reality that one quarter does not make a trend, P&G also needs to take care of its fiscal house to prove that it is not adrift, but on track.
The article Procter & Gamble: On Track or Adrift? originally appeared on Fool.com and is written by Asit Sharma.
Fool contributor Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Kimberly-Clark, Procter & Gamble, and Unilever.
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