Tuesday, September 1, 2009

* What's Wrong With P&G?

Product demand for household and personal care products is generally stable and not affected by changes in the economy or geopolitical factors. Investors know this and when the economy and the market turn down, many investors start buying defensive stocks. Since the end of the year, many non-cyclical companies have seen dramatic increases, with one notable exception, Procter & Gamble (PG).

Below are the dividend adjusted price growth from December 31, 2008 to July 31, 2009 for 5 prominent non-cyclical companies:
  • Johnson & Johnson (JNJ) - Up 3.5% - Analysis
  • Colgate Palmolive (CL) - Up 7.8%
  • Kimberly-Clark Corporation (KMB) 51.47/58.45 - 13.6% - Analysis
  • Clorox Co. (CLX) 51.13/61.01 - 19.3% - Analysis
  • Procter & Gamble Co. (PG) 60.38/55.51 - (8.1%) - Analysis
The above begs the question, what's wrong with PG?

The company spent the last several years investing in high-growth businesses such as beauty and divesting lower-growth staples like food. This left the company exposed to recessionary conditions. Management recently admitted that pressure on beauty and snack brands has been intense, leading to the 11 per cent decline in fourth quarter sales. PG's Chairman, A.G. Lafley, stated:
“In fiscal 2009 and particularly in the fourth quarter, P&G faced one of the most difficult macroeconomic environments in decades. We made choices to focus on cash and cost discipline, maintain investments in long-term growth opportunities and to protect the structural economics of our businesses around the world. We delivered strong free cash flow - the financial lifeblood of the business - while also delivering organic sales and earnings-per-share results that balanced short-term returns and long-term investments.”
On the plus side, PG has a good management team and excellent financials. The company has a respectable Free Cash Flow Payout of 47% and a good Debt to Total Capital of 39%. None of the companies listed above, with the exception of JNJ, can boast of such strong financial metrics.

As early as May, PG's management announced plans to increase offerings of lower-priced products. This is a significant shift in its strategy of introducing increasingly sophisticated (and costly) household staples. Lafley noted that every business is working to reach more consumers by widening the price range of its products. He cited the recent success of the company's bargain-priced Gain detergent and Luvs diapers compared to the premium-priced brands, Tide and Pampers. Mr. Lafley told investors:
"You have to see reality as it is. In every recession there are hosts of compensating consumer behaviors as they manage a more modest budget. We have to expand our portfolios to serve the needs of those consumers. I think a lot of that is going to last."
In addition, on August 24th, PG announced that it is selling its pharmaceuticals business to Irish drug maker Warner Chilcott for around $3.1 billion. The company stated the sale was geared toward prioritizing investments in its consumer health care businesses. The deal is expected to close in November.

I still have confidence in PG and will continue to add to my position as market conditions and my allocation allows. When a company is in turmoil, it often creates the best buying opportunities.

Full Disclosure: Long JNJ, CL, KMB, CLX, PG. See a list of all my income holdings here.

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