Gillette, Mock Thee? (Drip Port) July 15, 1999

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Gillette, Mock Thee?
The Mach 3 and Quarter 2 Earnings

by Jeff Fischer (TMFJeff)

ALEXANDRIA, VA (July 15, 1999) -- Early morning is a pristine time of day. The sun is in the sky but it's not too intense; the summer air is comfortable and inviting; one's mind is clear and the day is open to possibility. There is calm. Peace. Promise.

Then you turn on the electric razor.

BUUUUUUUUUZZZZZZZZZZZ....

Birds scatter from the trees outside the windows, your mind jumps in sensitive waves of reaction against the grating noise -- and then, even worse, you begin to saw away at your face.

Years ago, I received the gift of an electric razor at my doorstep. It was a Braun, which is owned by Gillette (NYSE: G). It was nice. After a few days, the old razor blades I had went in the trash and the Braun claimed its noisy, permanent place in every morning. The only downfall is that mornings haven't been quiet since.

Finally, five years later, the blade idea returned following a dead electric razor. "I wonder if a blade...."

I soon bought a two-bladed Gillette razor. The next morning, I bravely put it to test. After not using a blade for so long, the result was red. Red neck. Red face. And then, to top if off, two nice cuts on the chin, one cut by each blade. I was glad that it wasn't a Mach 3. There might have been three cuts.

I quickly dismissed the idea of a blade and a Braun electric razor returned to the scene. Until recently.

Visiting Europe, the need for a blade arose again. Risking death (or at least three large cuts), I nervously purchased a Mach 3 from a French supermarket. The woman at the cash register didn't need to understand English to realize that I was tentative about the 3-bladed purchase that I was about to put to my face.

The next morning, using Aveeno shaving cream -- which is excellent and is owned by Johnson & Johnson (NYSE: JNJ) -- I opened and inspected the Mach 3. The shaving commenced. Tentative at first. A slow swipe here. A cautious swipe there. Steady. Slow. Fight nothing. Rush nothing. We're talking about three blades to the neck here.

Gradually, however, confidence began to build in equal proportion to a quickly declining fear. Shave here, shave there. Quicker. Faster. Braver. Shave, shave, shave. Like the actors do on TV. No worries. A cut is furthest from the mind. Almost.

Nearly finished with the initial "flight" and the Mach 3 has flown wonderfully. Not even the smallest of cuts -- and that's unusual after not using a blade for so long. Rinse. Look for hidden disasters. All is good. Mach 3 passed with flying, impressive colors. After a few more days, it had found a permanent new home. The mornings (or, um, afternoons, as the case may be) now allow for peace once again.

This peace alone should be worth $5 billion in market value. In fact, the Mach 3 probably is worth at least that much to Gillette. The Mach 3 hasn't been Gillette's real problem.

Today, Gillette announced second quarter earnings of $0.26 per share, in-line with its guidance given on June 17 -- guidance that was far short of previous estimates. Second quarter profits declined 19% from last year, to $300 million. Sales rose 3.8% to $2.41 billion.

Gillette's stock has fallen nearly 30% in the past year versus a 20% gain in the S&P 500. Being a much-respected company facing several challenges -- none of which are insurmountable -- Gillette might be an interesting direct investment candidate for some investors. It would at least be considered more seriously here if the fees in its plan weren't of concern to us.

Gillette is mainly suffering from slower sales of higher-end products overseas, products such as Braun razors and Papermate stationery, as well as toiletries. These product lines account for nearly 35% of annual revenue. Elsewhere, Duracell battery sales rose, but profits from this product fell significantly, too.

Selling outside of North America provides lower returns whenever the value of foreign currencies declines, and decline they have. Asia has been a disaster for the last three years, and the Euro has declined 13% from its promising January debut. We've seen currency devaluations impact Coca-Cola (NYSE: KO) and Johnson & Johnson, too, in the past -- both companies sell aggressively overseas. Gillette is no different.

Gillette's profits were also lowered by an expensive marketing program for the Mach 3. However, marketing is proving effective at pushing what is a great product. Gillette states that the year-old Mach 3 already commands nearly 17% of the North American market for razor blades. The Mach 3 is doing especially well with younger buyers, which bodes well for future sales.

Gillette didn't provide specifics, but management stated that a recovery in toothbrushes, Braun, and stationery products should push earnings growth back to traditional levels. What level is that? Hard to say. Fool Matt Richey wrote an excellent summary of Gillette's past promises and recent woes on June 18. The company is chasing growth at high cost, and when growth doesn't result, costs compound without reward. Gillette isn't going away, of course, but from this valuation, when will it begin to reward shareholders in earnest again? As with Coca-Cola stock, Gillette has been flat sailing, and at the current valuation this might not change anytime soon.

Such a situation might be ideal for direct investors who hope to build a base in the unmoving stock, but only if they can be reasonably sure that growth will eventually resume at a market-beating, respectable pace. How can one be sure with Gillette? At this stage, you need to trust the company's size as an indicator of past success that will lead to more success, its product line, and its management.

Brian and I have talked about consumer goods companies before. In this sector, Clorox (NYSE: CLX) is on our Interest List. We'll consider such a stock if an interesting opportunity arises. While some Fools may be interested, the fees in Gillette's plan and the low level of confidence-building guidance from management don't make us want to cut to the chase and buy shares. But those Mach 3's sure are nice.

Fool on!

-Jeff Fischer

Call Your Boss a Fool.