How Can Lafley Keep P&G Expanding?

Analysis: Q3 Didn't See Broad Gains on Rivals; Key Brands Struggled

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BATAVIA, Ohio ( -- A.G. Lafley's turnaround of Procter & Gamble Co. has been little short of miraculous, and the package-goods giant continues to beat its stated targets. Yet the question is being asked: Can the sorcerer keep conjuring organic growth with his marketing magic, or is it time to bring in the bankers and divest some of the company's poorer-performing brands?
A.G. Lafley
A.G. Lafley's beauty business and Gillette acquisitions are hallmarks of the package-good giant's transformation of the past seven years.

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Not the Norm
P&G Was in the Middle of the Pack in Terms of Growth During the Last Quarter

These are among the questions on the minds of investors and even analysts who back the company's stock after P&G delivered fiscal third-quarter results earlier this month that failed to impress the market. Despite the fact that P&G delivered against its growth goals, the stock, which already had been lagging behind major market indexes and competitors for the past year, is down more than 4% since its earnings report.

That makes the stock a bargain in the eyes of some P&G watchers and makes it seem preposterous to P&G that anyone would second-guess Mr. Lafley's ability to pull another trick from his sleeve. After all, the company expects to deliver a phenomenal 18th-consecutive quarter of organic-sales growth at or above 5% in the current quarter, as well as continue to meet its double-digit earnings-growth goals (factoring out costs of the Gillette deal).

Brands still lagging
But it's also clear P&G stopped broadly gaining market share on major competitors last quarter for the first time in years, and that a growing number of its brands are struggling (defined in most cases as losing market share for more than a quarter). Once-high-flying Iams pet food and SK-II cosmetics most recently joined that list. After years as a world beater -- defying the laws of gravity in a competitive industry where turnaround stories have trouble lasting beyond a few years -- P&G suddenly is getting beaten in some markets.

P&G's much-heralded beauty business and Gillette acquisition, both hallmarks of Chairman-CEO Mr. Lafley's transformation of P&G in the past seven years, aren't helping. In fact, they've pulled down company sales growth in recent quarters, not boosted them as expected. Blades and razors had organic-sales growth last quarter of 4%, compared to 6% for P&G overall, while sales of the Braun and Duracell brands -- both billion-dollar behemoths in their own right -- were flat.

The latest results have fueled speculation that, within the next 12 months, P&G will shed three or four of its slowest-growing billion-dollar brands -- including Duracell, Pringles and Folgers -- and ramp up restructuring considerably, including in its U.S. marketing ranks.

Heavy restructuring costs
Mr. Lafley and Chief Financial Officer Clayton Daley in a May 1 conference call said restructuring costs in the year starting July 1 will exceed P&G's recent history. A P&G spokesman said the charges next year will be "well under $500 million," compared to the $150 million to $200 million in restructuring costs in recent years.

"P&G isn't as lean as a lot people think," said Sanford C. Bernstein analyst Ali Dibadj in a conference call with investors last week, though he added, "It's not their style to come out with a major restructuring."

Some Gillette veterans who have left after spending time at P&G also have noted much more extensive staffing and segmentation of marketing at P&G. Among areas P&G has been studying in recent months as part of its "Deliver the Decade" efficiency effort is how brand teams in its global business units and marketers in its regional-market-development organization work together, and, in some cases, overlap.

But while Mr. Dibadj can see some room for improvement, he also put an "outperform" rating on P&G's stock, which he sees as the strongest play in the industry. He said investors have beaten it down too much over concerns about slowing top-line growth and the Gillette integration.

While he believes P&G may have more trouble taking share from competitors in the future than it has in the recent past, he also said the company has much stronger businesses and management than in 2001, the last time it was valued so low relative to peers.

Giant spinoffs?
Morgan Stanley's Bill Pecoriello, who also has a buy rating on P&G and believes it's substantially undervalued, suggested in a note last week that P&G may spin off the entire snack, coffee and pet-food global business unit, as well as Duracell, which was acquired in the Gillette deal.

"A.G. is frustrated. Everybody is frustrated," said one person close to P&G, who put a 20% probability on P&G spinning off Duracell, Pringles and Folgers within three months and a "97.3% probability" of spinning them off within seven to 12 months. The pet business, this person believes, is a keeper for now.

Another person familiar with the company believes a spinoff of Duracell is "a done deal" as soon as P&G can do so in October under tax regulations related to the Gillette acquisition.

A P&G spokesman declined to comment on divestiture speculation.

Gains not good enough for some
It's remarkable that speculation about ramped-up restructuring and major divestitures are swirling at all regarding a company meeting or exceeding its stated targets. But some analysts believe P&G's results last quarter were unimpressive given comparisons to a year-ago period, in which sales were weakened by a major Wal-Mart inventory reduction and several one-off problems in China and Russia. "They should have knocked it out of the park, but they didn't," said one analyst of the top-line number.

A P&G spokesman said organic sales growth in the year-ago period was actually strong -- at 6% -- and stronger than that of many competitors. Morgan Stanley noted that the average for home and personal-care competitors last quarter was 6%, the same as P&G's, and ranging from 3% for Energizer Holdings to 8% for Colgate.

But unlike P&G, competitors such as Unilever, Colgate-Palmolive Co. and Kimberly-Clark Corp. -- all in the sweet spots of their own restructurings as they plow savings into stepped-up marketing -- beat investor expectations last quarter.

"It seems like every quarter [P&G] blames another part of their business for growing slower than expected," said an investor on Bernstein's conference call last week.

Rising Tide lifts all ships
Thank goodness Tide had a good year -- and quarter -- as P&G veterans used to say. Tide, and the rest of the fabric- and home-care business, were the primary growth engines allowing P&G to hit its targets last quarter. The paper businesses -- toilet paper, paper towels and diapers -- also did well, as did toothpaste, Prilosec OTC and Vicks.

That's not bad, but it's also not how it was supposed to work for a company that has invested nearly $70 billion under Mr. Lafley to move away from supposedly slower-growing home-care categories and toward supposedly faster-growing businesses, such as hair colorants, Wella and Gillette.

The P&G spokesman said all its deals have delivered on their projected economic goals and noted top-line successes in some of the prior ones, such as the Nice 'n Easy range of Clairol and Wella's fragrance business, which he said is pushing P&G toward possible global leadership in prestige fragrance.

More marketing money
One clear solution P&G plans is to increase marketing spending next year, which Mr. Daley vowed on the May 1 call.

But Mr. Pecoriello said in his note last week that investors appear to be banking on P&G hiking spending much more than it probably will. He believes the market expects P&G to boost marketing spending 20% globally, or $1 billion. He believes competitors will boost spending this year by 12%, requiring P&G to spend only an additional $300 million in its fiscal year starting July 1 to keep up.

He also believes investors are unfairly penalizing P&G for spending more on marketing without giving it credit for any improvement in sales growth that may generate. "P&G's recent top-line trends do not signal a crisis requiring a major step-change in spending levels," he said. And while he believes concerns about last quarter's top line are legitimate, he also believes P&G can meet its growth goals over the next three years.
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