5 Things I Learned From Reading Procter & Gamble's Annual Report

"Other guys read Playboy. I read annual reports."
-- Warren Buffett

I'm not quite as fanatical as Warren, but I do enjoy digging into a company's annual report (called a 10-K) to learn something new. Especially for companies I own.

Over the next few weeks I'll be reading the 10-Ks of all the companies I own shares in, first page to last.

First up: Procter & Gamble (NYSE: PG  ) . Here are five things I learned from P&G's annual report (which you can read here).

1. It has a huge reliance on Wal-Mart (NYSE: WMT  ) I always knew Wal-Mart sold a large amount of Procter & Gamble's products, but I didn't know exactly how much. The figure shocked me. 

"Sales to Wal-Mart Stores, Inc. and its affiliates represent approximately 14%, 15% and 16% of our total revenue in 2012, 2011 and 2010, respectively."

That's huge. Think about it: P&G is one of the world's largest consumer-product companies, and one retailer is responsible for one-sixth of its sales.

"No other customer represents more than 10% of our net sales," the 10-K reads.

For perspective, Asia made up 18% of Procter & Gamble's total sales in 2012, while Latin America made up 10%. So, Wal-Mart alone sells 40% more Procter & Gamble products than are sold in all of Latin America.

2. Without international exposure, the company would be a mess.
Take a look at this table:

Net sales (in billions)

Year

United States

International

2012

$29.5

$54.2

2011

$29.9

$51.2

2010

$29.5

$48.1

P&G's total sales are growing -- but barely. And what little growth it is squeaking out is coming entirely from overseas.

That highlights two points. One, diversification is one of this company's key strengths. Two, U.S. consumers don't have nearly the appetite for brand-name products that they used to. Generics sold by companies like Costco have gained consumers' attention.

3. Advertising isn't working like it used to.
Why would anyone buy expensive laundry soap when the cheap bottle of generic probably works just as well? Because Procter & Gamble spends a fortune on advertising to convince consumers that its products are worth the money.

Problem is, the effectiveness of its advertising seems to be waning. Over the last five years, revenue growth has slowed while advertising as a share of revenue has increase. In other words, the amount of additional sales it gets from additional marketing is dropping: 

Year

2012

2011

2010

2009

2008

Revenue growth

3%

5%

3%

(3%)

9%

Advertising as a percentage of sales

11.2%

11.4%

10.9%

9.9%

10.8%

The key to P&G's future is maintaining the quality of its brands, and the most effective way to do that is through advertising. I suspect consumers will be more responsive to advertising when the economy picks up and employment growth returns, but the current trend isn't encouraging.

4. There's a lot of variance in margins among its internal divisions.
P&G splits its business up into five divisions: beauty, grooming, health care, fabric care, and baby care.

I assumed all would have roughly similar margins, given the common denominator of "premium household goods." But there's actually quite a bit of variance, with grooming pulling in nearly double the margin of beauty:

Division

2012 net earnings margin

Beauty

16%

Grooming

29%

Healthcare

22%

Fabric care

17%

Baby care

20%

Most of the outperformance in grooming can likely be explained by Gillette's massive market share. "Our global blades and razors market share is approximately 70%," the annual report says.

5. Two sentences explain a large part of why the company has made a great investment.
Procter & Gamble has produced an average annual return of 12.14% per year since 1968. This is largely thanks to the pricing power of its brands, but two sentences in its annual report also explain part of the gain:

Our first discretionary use of cash is dividend payments ... [2012] is the 56th consecutive year that our dividend has increased. We have paid a dividend in every year since our incorporation in 1890.

Some companies are run for the benefit of management. Others will move mountains to take care of outside shareholders. P&G is the latter, and it shows. 

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Read/Post Comments (9) | Recommend This Article (30)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 06, 2013, at 7:12 PM, alan0101 wrote:

    Pretty naive analysis, no value added.

  • Report this Comment On May 07, 2013, at 7:19 PM, chris293 wrote:

    For the most part, 'Store Brands' usually are inferior to name brands like P&G. Yes, I will buy some store brands to save money; but, then mix what I buy with the good brands. I do this less often now since you will always end up with a poorer product. You can not beat quality!

  • Report this Comment On May 10, 2013, at 12:49 PM, WineHouse wrote:

    This article makes some rather specious statistical comparisons. Perhaps it is because the author himself is ignorant of the penetration of Wal-Mart and its international subsidiaries into the retail supermarket sales business in countries outside the USA. Nonetheless, the result is that his data are not valid because they are based on incorrect assumptions and false comparisons, Let me explain.

    About ten years ago, I traveled to Cancun, Mexico for vacation, and I was SHOCKED to discover that the biggest -- and busiest by far -- retail sales store in the city of Cancun (on the mainland, in town) was a Wal-Mart. And NO, it wasn't primarily tourists who were shopping there. It was primarily the locals! The local Mexican population did an enormous amount of their shopping there in that huge Wal-mart, including fresh produce, fresh meats, and packaged foods of all sorts. Of course, the store carried major brands that were familiar to me (even though the packages were generally prepared by the Mexican subsidiaries of those companies), and P&G was certainly represented, along with Colgate-Palmolive, Unilever (which is a UK/Dutch co-company that has manufacturing plants in the US for its American subsidiary business and owns many familiar brands such as Hellman's Real Mayonnaise), and many many others of that ilk.

    There are Wal-Mart subsidiaries operating all over the globe, not just in Cancun.

    So to separate out "Wal-Mart" collectively from the individual foreign countries is specious, and the data as presented in this article is thus worthless without a similar breakdown of WalMart's portion of each country's portion.

  • Report this Comment On May 15, 2013, at 3:52 AM, cyclelogical wrote:

    Are you aware of the following:

    Wal-Mart's revenue is $1.2 million/day.

    Wal-Mart will sell more from January 1 to St. Patrick's Day (March 17th) than Target sells all year.

    Wal-Mart is bigger than Home Depot + Kroger + Target +Sears + Costco + K-Mart combined.

    (The above three points based on annual revenue.)

  • Report this Comment On May 15, 2013, at 3:27 PM, silkonconcrete wrote:

    Very poorly conceived article. Let us review the following points.

    1. Wal-Mart is the largest retailer in the world, and the high sales to walmart also show that P&G is very popular. Once might also posit that walmart has dependence on stocking P&G products. It would be very strange if walmart was NOT the largest buyer

    2. P&G should sell more internationally and continue to do so. there are billions of customers outside of the U.S.A. and only about 300 million in the U.S.A. A more appropriate reading of this metric is that P&G is still more reliant on the U.S.A. than it should be.

    3. correlation is not causation. In 2008 we had a financial crash--P&G was able to purchase advertisement at a much lower cost than it can today. This analysis would need to take in at least a decade of data to have any sort of meaning.

    4. If you assume that different products should have similar margins, you need some basic business education. Razors will never have the same margin as detergent--health care that demands a lot of R&D will NEVER have the same margins as anything else. What is surprising is how large some of the margins are in areas that could be viewed as commodities.

    5. ummm.... are dividends part of the 12% return noted. While dividends are good, they do not explain returns, as it is returns. The business generates profits which cause the return.

    Not a very smart article--but maybe the author knows that.

  • Report this Comment On May 15, 2013, at 3:46 PM, TMFMorgan wrote:

    Criticism noted and at times well deserved. Some of the rebuttals are a little offbase, but I'll try to do better.

    -Morgan

  • Report this Comment On May 16, 2013, at 10:50 AM, boogerface02211 wrote:

    There is some validity in a few of these criticisms, but in general, they are too harsh and obnoxious. It is an interesting article and I am a more informed PG shareholder fhan I was before reading it.

  • Report this Comment On May 16, 2013, at 11:00 AM, TMFKopp wrote:

    Ditto boogerface (and +1 on a great screen name)

    I'm puzzled at the comments here. The article raises some interesting points and while seasoned P&G investors may have already pondered these and gotten comfortable with risks they pose, I see them as very crucial points that need to be considered.

    Matt

  • Report this Comment On May 20, 2013, at 4:32 PM, silkonconcrete wrote:

    I actually rarely write criticism, but I feel that Morgan wants to write something valuable. I think he needs some assistance in how to read an annual report.

    Just to take one point "advertising is not working as it should be." He cannot simply take % of revenue and apply it to revenue growth. In this way he is ignoring exogenous factors in the model. Marketing spend is not the only factor in revenue growth. I do not find this criticism to be harsh--I find the author's statement to be harsh.

    TMFKopp talks about risk. What risks are in this article, and what is the magnitude. A discussion of Walmart's buyer power could have been appropriate, but do you believe that reducing exposure to Walmart would benefit shareholders? if so how?

    Without international exposure the company would be a mess? This is a strange statement. What does the author want? More sales in the U.S.? Less sales outside the U.S.? Author needs to make sense, and it should make sense from a shareholder perspective. This article does not. sadly.

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