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Topic: Wealth Management

Fewer brands, higher profits is Procter & Gamble’s strategy

Investment CounsellorEvery Thursday we bring you our best U.S. stock picks. You get our specific recommendation on the stocks we profile, with a full explanation of how we arrived at our opinion. You will read about stocks making moves you should know about, most often from coverage in our newsletter on U.S. investing, Wall Street Stock Forecaster.

Procter & Gamble’s sales have slowed in recent years, mainly due to competition from cheaper generic brands. In response, the company is eliminating less profitable household goods and cutting costs. It’s also doing a good job of developing new products and finding new markets for existing ones.

These moves will give Procter more room to adjust its prices without hurting its profit margins. They’ll also provide more cash for share buybacks and dividend hikes.

PROCTER & GAMBLE CO. (New York symbol PG; www.pg.com) began operating in 1837 and is now one of the world’s largest makers of household and personal care products.

The company has five main business lines: fabric and home care products, such as Tide laundry detergent (32% of fiscal 2014 sales, 26% of earnings); baby and family care goods, including Pampers diapers (25%, 25%); beauty items like Olay cosmetics (24%, 23%); grooming products, including Gillette razors (10%, 17%); and health care items, such as Crest toothpaste (9%, 9%). Wal-Mart accounts for 14% of the company’s sales.

Procter’s sales fell 1.3%, from $84.2 billion in 2013 to $83.1 billion in 2014. That’s because Procter sold 80% of its pet food business to Mars, Inc. for $2.9 billion. It expects to complete the sale of the remaining 20% in 2015. Earnings were $4.22 a share (or $12.2 billion) in 2014.

Procter recently agreed to sell its Duracell battery division to Berkshire Hathaway Inc. (New York symbol BRK.A) the holding company controlled by Warren Buffet.

Berkshire will exchange all of its Procter common shares, worth roughly $4.7 billion, for Duracell. In addition, Procter will contribute $1.8 billion in cash to Duracell. This transaction will let both Procter and Berkshire avoid paying substantial capital gains taxes.

The sale of Duracell and the pet food business is part of the company’s new plan to sell around 100 of its less profitable brands.

Following these sales, Procter will have around 80 brands that combined supply 90% of its sales and 95% of its profits. This tighter focus will cut the company’s manufacturing and distribution costs.

Of the brands Procter is holding onto, 23 have individual sales of over $1 billion a year. A further 14 have annual sales of between $500 million and $1 billion.

Meanwhile, the company continues to streamline its operations, including closing plants and laying off 5% of its workforce. Procter expects severance and other related costs to total $4.5 billion. However, these moves should lower its annual expenses by $2.8 billion after it completes the plan in 2016.


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Stock advice: P&G developing innovative new products

The company will use some of these savings to develop innovative new products.

For example, it has teamed up with appliance maker Whirlpool to develop the Swash, a device that freshens and removes wrinkles from clothes in 15 minutes without ironing. Whirlpool will make the device, and Procter will sell the specialized detergent pods.

The Swash seems expensive at $499, but Procter feels it will be a success, as people who use dry cleaners typically spend around $750 a year. Its research also shows 80% of its customers avoid ironing.

The company has also developed an industrial version of Tide detergent that uses cold water and a neutral pH formula that helps fabrics last longer. This should appeal to large customers like hotels and hospitals, because it would mean fewer linen replacements and lower power costs.

Procter’s research spending rose 2.2% in fiscal 2014, to $2.02 billion (or 2.4% of sales), from $1.98 billion (or 2.4% of sales) in 2013.

The company is also shifting its advertising away from TV and print and onto the Internet. That cuts Procter’s costs. The move also lets the company target specific buyers and better promote its products through social media channels like Facebook and Twitter.

Meanwhile, Procter’s balance sheet remains sound. As of June 30, 2014, its long-term debt was $19.8 billion, or just 9% of its market cap. It also held cash and short-term investments of $10.7 billion, or $3.94 a share.

The company is using more of its cash to buy back shares. It spent $6.0 billion on repurchases in both fiscal 2013 and 2014 and will probably spend the same amount this year.

Procter also recently raised its quarterly dividend by 7.0%, to $0.6436 a share from $0.6015. The new annual rate of $2.57 yields 3.1%. The company has paid dividends for 124 years and has increased its payout annually for the past 58 years.

The stock has gained 23% in the past two years and now trades at 19.2 times the $4.38 a share that Procter will probably earn in fiscal 2015.

That’s a high multiple for a slow-growing consumer products company. However, Procter’s strong brands will help it continue to increase its sales in developing markets, which supply 40% of its overall revenue. That’s helping it offset slowing sales in more established markets like Europe.

As well, more people in developing countries can now afford Procter’s products, particularly razors and other items for personal grooming, which have higher profit margins than the company’s soaps, detergents other goods.

Procter & Gamble is a buy recommendation of our advisory on U.S. investing, Wall Street Stock Forecaster.

Coming up Next

Tomorrow we look at how a Canadian leader in aircraft parts holds its position in a competitive international field.

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