The Biggest Problem Facing Procter & Gamble Co Stock Right Now

Image Source: Procter & Gamble.

For a company that sells staples like toilet paper, diapers, and razors, Procter & Gamble sure has a volatile business these days. Profits dove in its last fiscal year as foreign markets were wracked by currency devaluations, political instability, and economic shocks.

At the same time, P&G's portfolio is going through its biggest realignment in the company's 111-year history. Management whittled down its brand list to just 65 from nearly 170. Most of the jettisoned franchises are small, underperforming brands, but a few, like Duracell batteries and Coty beauty products, have played a key role in growth.

The deeper problem is that P&G is losing market share, which has produced disappointing returns for investors lately.

The problem

P&G expects to post organic sales growth in the neighborhood of 1% in the fiscal year that ends in August, representing no improvement over the prior year's lukewarm result. That figure understates P&G's struggles since it has been inflated by higher prices. P&G's sales volume is down across each of its five product categories over the last nine months.

Organic sales growth. Source: P&G financial filings.

Rivals are faring much better. Clorox just raised its 2016 outlook after posting 4% higher sales volume. Unileverand Kimberly-Clark are moving more products, too, and expect to post between 3% and 5% growth this year.

This matters because P&G's sales growth pace is the foundation of its business. Management's long-term financial targets all start with the goal of achieving "organic sales growth above market growth rates in the categories and geographies in which we compete," executives explain in its 10-K report.

How P&G is fixing it

The biggest portion of P&G's response has been financial. The company is aggressively slicing costs in every operating segment, from headquarters to manufacturing overhead, to the supply chain. As a result, it is much more efficient. Cash flow production as a percentage of earnings hit a new high recently and profitability spiked.

Image source: P&G.

The second strategic response isn't as easy to quantify, but it's just as important to the business. P&G's portfolio transformation plan involves removing brands that had a slower growth profile and weaker profitability than the overall company.

In most cases that has left only those categories and brands that P&G dominates, like detergent and diapers. CEO David Taylor and his executive team believe the new portfolio, while slightly smaller, will enjoy market-beating growth and operating margins.

Getting rid of underperforming brands will help, but any long-term answer will also need to involve better innovation. After all, P&G hasn't launched a new billion-dollar brand in more than a decade, which raises the question of where its $2 billion of annual R&D spending is going.

The path forward

The good news is that there are bright spots, like in laundry detergent and fabric care, that show a possible way forward for the company. Leading the industry in innovation with detergent pods, scent beads, and new upgrades like Tide PurClean is helping P&G produce market-beating growth in the U.S. As a result, value-based private store brands aren't posing as much of a challenge in this category.

The true evidence of a turnaround here will be faster organic growth, especially organic volume. Investors can celebrate the fact that cost cuts and brand divestments are raising tons of cash and keeping shareholder returns marching higher even as net income falls. However, that's not going to snap P&G's two-year streak of lagging sales growth without help from a few hit product introductions.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends Kimberly-Clark, Procter and Gamble, and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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