|Shareholder activist Nelson Peltz made P&G his next move. Round one has ended.|
P&G has grabbed headlines in recent days. A shareholder activist has made moves to "shake up the company." Nelson Peltz, the activist acting on behalf of his Trian fund, wants to reorganize the company to improve results and shareholder returns and made bids to try to get a spot on the board. He and his fund own about $3.5 billion of the stock and launched formal proxy efforts.
The activist says he doesn't want to oust current management and replace with his own appointees, nor he does he claim to have devised revolutionary strategies and product ideas. He wants to reorganize in a way to permit outsiders to understand performance better and hold managers accountable.
Although not the same, it appears similar to how Google reorganized itself into the Alphabet holding company and separated out the search-engine business from other innovative or different activities, at least to permit investors to dissect each business activity carefully. Business activities are not bundled into single operations, and managers and investors know for sure what's growing, what's profitable, and what's worth investing in for the long haul.
P&G hasn't ignored Peltz's pressure and responded with vigor, reaching early-round triumph in the recent proxy move.
But what is it about P&G's performance the past decade that irks him and stirs such activism? Sometimes it's not about specific performance, but specific performance compared to others in the industry. Sometimes it's about a reorganization to figure out what's profitable and what's not, and what should, therefore, be sold off or shut down.
In the consumer-goods industry, that will likely mean they measuring P&G's share performance against the likes of Colgate-Palmolive and Kimberly Clark.
Needless to say, with all the commotion about business reorganization and board seats, the stock price has jerked around a bit the past several days. By most measures, share price (now hovering about $91-92/share) has increased steadily since it experienced brief dark moments in late 2015 (when the broader market was in a downswing). The stock's price-earnings (P/E) ratio ranges between 24-25 range. In some circles, investors might suggest it's over-valued. Activists will contend it's not where it could be.
The company, like others in consumer goods and products, has reached levels of stagnation. Revenues haven't grown over the past several years; in fact, they have declined. Profits, therefore, have remained flat.
What had been a $74 billion-revenues company will not likely eclipse $65 billion in revenues this year. Facing markets in very mature product lines and encountering tough competition wherever it turns, the company has worked to cut costs to maintain profits and to generate returns investors want to see in a bustling economy. The company appears to have done well to reduce costs across the board, which explains why operating profits are flat when revenues are down.
Returns on capital deployed (book capital) have climbed above 20%. The company is resorting to financial maneuvering like other mature companies in a similar scenario. Revenues are flat, because product offerings are mature and global expansion has peaked. Hence, to achieve reasonable returns on capital, companies like P&G focus on (a) cost control or cost curtailment and (b) rewarding shareholders with big dividends and share repurchases. They also resort to reducing overall funding costs by substituting cheap debt for expensive equity.
Returns on capital rise, and share prices could actually climb (because of dividends and the certainty of cash flow generated from old products year after year after year). Share prices inch upward, but they may not soar. Activists take big stakes and then insist they have the right strategies to help the share price surge.
Debt at P&G now totals a manageable $31 billion (including short- and long-term debt). Operating cash flow of about $9-10 billion annually (even after accounting for capital expenditures), as well as cash reserves of about $10 billion on the balance sheet, can handle the debt burden. Ratings agencies award it a AA- rating, stellar by most standards.
Now compare with Colgate-Palmolive, a peer, where shares trade at a higher multiple (28 P/E) and which might have benefitted from recent market "concerns" about P&G, as its own stock has climbed almost 5% in the last week.
The numbers show CP wrestles with similar issues. The company is about a quarter the size of P&G and has also experienced steady declines in revenues. Like P& G, it has boosted profits from aggressive cost-cutting. It, too, keeps shareholders happy with consistent dividends and share buybacks, but hasn't had to increase debt to supplement operating cash flow (about $3 billion annually).
(CP has a market value at 10/13/17 of $66 billion, based entirely from predictable cash flows and the value of many brands. It has less-than-zero book equity.)
P&G, by comparison, is an elephant, a healthy one, but perhaps one that is walking uphill. Peltz might have launched his haunting of P&G by habit. He, his fund and other investment vehicles have habitually invested in large, mature consumer-products or consumer-goods companies. In past years, they have had stakes (and pursued activist strategies) at PepsiCo, Mondelez, Kraft Foods, and Wendy's. (He might best be known for stir-ups at DuPont two years ago.)
After an unsuccessful proxy effort, Peltz was shoved back to the sidelines. But the ball is in P&G's court, as it had announced it has its own well-crafted plan to determine a way grow an old, graying enterprise.
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