Will P&G Ever Turn Around?

 

Amid sagging sales and falling volumes, consumer-staples giant Procter & Gamble (NYSE: PG) has done little lately to earn its reputation as one of the best-run companies in the world. Will the recently announced sale of its pharmaceutical business to specialty-drugs developer Warner Chilcott (Nasdaq: WCRX) mark a turning point?

Premium brands lose appeal
First, let's understand that the global recession has been tough on P&G. Price increases on items ranging from Tide and Era to home- and dish-care products have turned away budget-conscious consumers. Meanwhile, competitors such as Unilever (NYSE: UL) and Colgate-Palmolive (NYSE: CL) have been able to keep a tighter grip on volumes. That puts any move Procter & Gamble makes under the microscope.

The Warner Chilcott deal is expected to net P&G $1.4 billion after tax, or about $0.44 per share. In exchange, P&G will relinquish its prescription drug product pipeline, along with established treatments such as osteoporosis drug Actonel. The logic, according to CEO Bob McDonald, is that P&G will be able to focus on its consumer health care business, where brands include Crest, Tampax, and Prilosec OTC.

Growth ahead?
It's difficult to know what form such focus will take. Some investors would undoubtedly like to see the company innovate on higher-margin premium brands. However, the better strategy may be to broaden the product portfolio into the value-price segment -- even if lower prices mean slimmer margins -- thus winning over more cautious consumers. Should P&G decide to compete on a price and value platform, look for new products in the OTC pain relief, cold, and flu remedy categories, where consumers are most likely to trade down to store brands, versus greater brand loyalty in the areas of cosmetic and skin and hair care.

In the meantime, I'd caution against unwarranted optimism. Management's move to open Mr. Clean-branded car washes doesn't exactly smack of a laser-like focus on its core business. Speaking specifically of divestitures, in past years, the company sold food brands Folgers, Jif, and Crisco to J.M. Smucker (NYSE: SJM). Given Smucker's recent quarter, holding onto those brands might've boosted P&G's recession-era performance.

The market gets it right
A common argument for buying P&G shares is that they're undervalued. Sure, the stock's P/E is low compared to historical averages, not mention many competitors' shares. Still, respected consumer names such as Kimberly-Clark (NYSE: KMB) and ConAgra (NYSE: CAG) go for lower forward multiples. Given that P&G is, from a certain perspective, a turnaround story that's yet to turn, this pricing appears warranted to me.

But if you do decide to jump in with a wad of dough and yellow rubber gloves, keep a close eye on company developments. This isn't the blue-chip company that your mother told you to buy and forget for 10 years. At least, not anymore.