Fair Value Estimates (FVE):
The average FVE is $65.12 against the current share price of ~$67.50.
Financials Summary:
Q2 2012 Quarter Report & Conf. Call – 01/27/2012:
Organic sales growth – 4%, volume – 1%: effect of pricing.
No growth in
developed markets. But, developing markets at 37% of sales compared to 27% of
sales 5 years ago is offsetting this factor well.
Market share in line or higher in businesses representing
~45% of global sales compared to 60% level in previous quarters – negative
effect of price increases – expects it to be temporary as price gaps narrow
either because of competitors following price increases or PG dropping the
price increase. But, global market share inline with prior year levels – held
or grew share in 9 of 15 countries, 3 of 6 reporting segments and 11 of 24
billion-dollar brands.
Core earnings down 3% due to higher commodity prices and tax
rate headwind. Also, divestiture of PUR business had an impact.
Good and intangibles write-down at $0.53 per share – onetime
non-cash – appliances and salon professional businesses – out period growth
projection reduced. Tax rate at 36.7%
due to the noncore nature of charges which are not tax deductible. Otherwise it
should have been 24.9%.
Six Reporting Segments Summary:
- Beauty
Segment: organic volume and sales growth of 2%. Retail hair care led the
growth with India Pantene shipments increasing 80% and China Head &
Shoulders shipments increasing 25%. NA weak – mid-single digit shipment
decline.
- Grooming
segment: Blades and razors volume increased low single digits. CEE, ME,
and Africa shipments in double digits mainly from expansion of Fusion
ProGlide. NA Fusion ProGlide sales offset by Mach3 losses.
- Health
Care Segment: Oral care volume down low single digits. Crest 3D White
growing. Oral-B toothpaste expansion markets delivered results ahead of
expectation.
- Fabric
and Home Care Segment: Organic sales growth of 5% - flat volume. Tide PODS
should start selling in less than a month. It could become the biggest
launch in the US consumer product industry.
- Global
Home Care Segment: Shipments up low single digits. Challenge – US auto
dish category were price was increased 8% - the consumer value versus
competitive products currently outside our range and so we will reverse
some of the price increases – to aggressively pursue cost savings to
maintain profitability.
- Baby
and Family Care Segment: Organic sales up 6% - mainly because of price
increase. Focus on strong 3-tiered portfolio.
Guidance:
Background - Tightened sales guidance and earning per share
guidance mainly because of foreign exchange impact – ruble, zloty, the real,
the peso, and the Turkish lira depreciated 10% to 20% against the dollar. These
along with pound sterling have caused the majority of earnings impact. Historically,
currency impact is offset by declining commodity costs which has not been true
so far – input costs still expected to be $1.8B higher. Developed markets all weak with US being the
only one growing, albeit slowly. Disproportionate growth in developing markets
also has an impact as absolute profit per unit is lower in the area.
Priorities:
- Maintaining our top line growth momentum – 4%
organic sales growth is good,
- Execute pricing changes with excellence. Some
corrections, but they are minor compared to $3.5B in increases this year.
Pricing to continue to be a significant driver of organic sales growth,
- Improving productivity – Reducing number of technical centers we operate
globally while opening new ones in developing markets – facility in Singapore
and R&D center in Beijing – operating closer to growth areas. Overhead to
be reduced by 1600 roles through selective hiring, normal attrition, and
restructuring. To announce more at CAGNY.
- Restore solid operating profit
growth – pricing should help – second half core operating profit growth to be
10 to 15%.
Guidance Summary – core earnings guided down to $4 to $4.10 from the
prior range of $4.15 to $4.33. So, EPS growth to be 1% to 4% compared to $3.95
in prior year. All-in earnings per share in the $3.85 to $4.08 range – includes
$0.55 to $0.65 per share gain from Pringles divestiture, restructuring cost in
the range of $0.15 to $0.80 per share and $0.52 per share in non-core charges
related to impairments, etc. Capital spending in the 4-5% range. Expect to pay
$6B in dividends and $4-5B in share repurchases.
Jan-Mar quarter guidance – organic sales growth in the 3-5%
range – compared to 4-9% projected for the back half. But, foreign exchange
expected to have negative impact of 3 points resulting in flat to 2% sales
growth range.
Q2 2012 Conference Call Q&A Summary:
Second year in a row
were you project back end loaded guidance only to retract. What gives?
Productivity increase is a focus. To talk more about this in
CAGNY. Top-line is growing. Bottom line is a function of macro effects. We will
try to offset with productivity increases. But, we can’t reduce spending to
offset costs as that will harm our long-term trajectory.
Pricing flexibility – please comment?
Overall successful in executing the pricing increases. There
are 3 exceptions were we had to take action. The percentage increase this time
around is much less and so it should be asier to implement. Also,
commodities rolled over last time with
our price increases. That is not likely to happen this time. Besides, we are
growing share now.
How is growth projected – volume vs pricing?
We will continue to grow top line and we are going to
continue to grow the market share. The strategy is to have a full portfolio of
offerings from premium priced to low priced. Example is laundry care currently
– Tide total care at the premium end, Tide at the average end, to Era at the
low end. PODS is the new innovation in the area. Crest 3D white is another
premium priced example. Innovation at the premium end is critical.
Volume will be a bigger component going forward. Out of 4 to
5 top line, 3 to 4 points will be volume – mix and pricing help.
Discontinuous innovation by – growing categories. Not seeing
that. Why?
You should be seeing it. Febreze auto product is an example
– gets us into a category in fragrances in automobiles that we have never been
in before. Tide PODS is another example – it will be expansive to the laundry
category – it’s the most condensed laundry product you can buy – much better
for environment – it is expected to be 30% of category.
Cost cutting needs to happen faster. Also, its just too
complex and needs to be broken up – what is your take?
Scale is a tremendous advantage. Wants to be in the
top-third in peer group w.r.t. total shareholder returns. Improving
productivity is part of the deal – you will hear more at CAGNY. We have been
doing similar to what Kraft did. The key question is whether we can scale and
win versus the more focused company and we think the answer is Yes.
Cost savings and role of advertising related question?
Over time, advertising cost increases should moderate – more
choices, less expensive in the digital space.
Macro Assessment:
Global economic growth is a big positive for the company.
Strong dollar is a negative.
Checklist:
1.
Is it a business I understand very well squarely within
my circle of competence? – somewhat.
2.
Do I know the intrinsic value of the business today
with a high degree of confidence? – somewhat.
3.
Is the business priced at a large discount to intrinsic
value today and in two to three years? – No, FVE showed it being fairly valued.
4.
Would I be willing to invest a large portion of my net
worth into this business? – No.
5.
Is the downside minimal? – may be – beta is low at 0.30
– so it should hold up very well in a correction.
6.
Does the business have a moat? – may be – many of its
products are household names and so there is a certain level of user loyalty.
7.
Is the business run by able and honest managers? – may
be – compensation is very high.
8.
How much is the Margin of Safety? – A good investment
needs good downside protection – margin of safety is very low but (~$65 was our
average FVE). beta is very low as well and so there is some downside
protection.
9.
Moats – A good
investment needs to have a good upside earnings engine. Is there a solid moat?
Could the moat be shrinking/evaporating? – see above.
10.
Is it a simple easy to understand business? – somewhat.
11.
Are the revenues and cash flows of the business
sustainable? Are you looking at normalized earnings or boom-time earnings? –
Example Cort Furniture purchase by Wesco – the volumes were high due to
Internet bubble – Buffett/Munger mistake. Given the complexity of the business,
it is tough to gauge – it appears we are looking at normalized earnings.
12.
Is it a Graham Net/Net play? – Bought below net working
capital. Special Situation – good downside protection and chance of high
returns, but probability is very low - Cash and short-term investments + (0.75
* accounts receivable) + (0.5 * inventory) - total liabilities. No – big
negative number.
13.
Is the company’s business becoming unregulated? – that
could cause the moat to quickly evaporate - regulated businesses have
high cost structures which would be disastrous in a competitive unregulated
landscape – an example of such a mistake is Warren Buffet’s investment in US
Air which he acknowledged as a mistake in the 1996 letter to shareholders. No.
14.
Assets to Equity – Is the company too leveraged? – the
ratio is at ~200% - so, the company is leveraged - good will and intangibles
make up roughly half of the assets.
15.
Could the company have made bad lending decisions? –
bank specific – NA.
16.
How much will high unemployment and recession hurt the
business? – it will affect the company negatively.
17.
Is the investment correlated to one or more of your
existing holdings? – holding many business that are correlated can result in an
undiversified portfolio – Yes – KFT is in the same general area (consumer
products conglomerate), but it is splitting up – after the split-up, will have
to reassess..
18.
Can this business be decimated by low-cost competition
from China or other low-cost countries? – example – Warren Buffett’s investment
in Dexter Shoes – No. But, private-label is a threat.
19.
Is this a win-win business for the entire ecosystem? –
avoids tobacco, gambling, predatory lenders, etc –Yes.
20.
Mohnish Pabrai has said he has ten check-list questions
on leverage – How much?, What are the covenants? Are they recourse or
non-recourse?, etc. – Not clear.
21.
There are five questions on management - Management
Compensation? Interests of Management – Is it aligned with shareholders?
Management’s historical track-record?, Does Management have a large stake in
the company? – Very little insider ownership.
22.
Unions & collective bargaining issues related
questions – Does the company have union issues? – don’t know.
23.
Pension funding status? – unfunded amount is pretty
high - ~$11B.
Quick Take:
As a huge conglomerate, the company is very complex – there
are myriad factors that affect the company that one needs to consider to
analyze it well. On a pure fundamental basis, the company has a TTM PE of 17.05
and because of the anemic guidance; the projected forward PE is down only by a
small amount to 16.5. The PE is comparable to companies in its peer group.
Our average Fair Value Estimate (FVE) came in at $65.15,
only a slight discount to the current price of $67.43. Financials show a
healthy picture with a couple of concerns: Asset to Equity ratio is high at
~200% indicating a fair amount of leverage and the Graham Net-Net is a large
negative number, again indicative of the large leverage.
The company has a focus on productivity & cost savings
and has a plan to realize ~$10B in productivity and cost savings by 2016. It
includes a target of ~$3B in overhead reduction. The savings has to come from a
projected $85B cost pool for 2016 that includes $52.1B in COGS and $32.8B in
SG&A. The projected savings account for 12% of the projected cost pool and
that level of savings is easier said than done. But, if the company is able to
pull off this, earnings-per-share could double based on this factor
alone, within the next 4 years. Investing in the company at the current price level
is a bet that the company’s management will be able to deliver on this
objective.
Last Updated: 03/2012.
