In this Industry Focus: Consumer Goods segment, the team discusses how Procter & Gamble (NYSE:PG) is taking the concept of SKU rationalization to an even deeper level with "brand rationalization". Management has shed dozens of brands from the P&G portfolio in an effort to revitalize the business, and there are some key metrics investors can watch to follow the company's progress.
A full transcript follows the video.
This podcast was recorded on Oct. 12, 2016.
Vincent Shen: I wanted to make sure we got to Procter & Gamble because they have been taking, I think, this whole process and reducing and optimizing their offerings to a whole other level with the amount of brands they have dropped recently and how they're trying to refocus their resources, their money, into basically what they see as the most profitable brand portfolio that they can possibly target.
Asit Sharma: Absolutely. If you take the concept of SKU rationalization and blow it up, there's a term for it. It's called brand rationalization. And that's what Procter & Gamble is up to. They also have been talking up their effort to reduce SKU count over the past several years. But a couple of years ago they woke up one day and realized, we have way too many brands in our portfolio. So, over the last 18 months, Procter & Gamble has exited, or consolidated, 61 of their brands and it's in the process of exiting 44 more by the end of this year. Again, going back to what we found in Unilever's case study, the brands that Procter & Gamble is getting rid of represented only 6% of profit during those 18 months. And when this whole process is completed, Procter & Gamble is going to be left with only 65 brands across 10 major categories.
Shen: So let me hop in there really quick. One thing I wanted to make sure we touched on for listeners was also just previously, over the summer, we'd done a show that's somewhat related to this, was around inventory turnover, inventory management, and there's a point here, a metric here, for Procter & Gamble that really stands out to kind of show how this brand rationalization that you mentioned has benefited them. So let's touch on that, and then also I'd love if there are any other metrics. I know there's nothing that is one-to-one necessarily with SKU management and with reduction that investors can look at, but what other metrics can investors use when trying to evaluate a company's effort in this space?
Sharma: Sure. Well, you've touched on a really great one. This is a metric that you can find on many financial websites, but if you look at days of inventory outstanding. When you hear that a big company is trying to become more efficient with its product lines, there's a way you can see if they're being effective or not. Procter & Gamble before this effort, the other day, had a days inventory outstanding of 78 days. What that means is that it takes Procter & Gamble about 78 days to cycle its inventory on average and it replaces its inventory about 78 days, if you average everything out. Through this process, P&G now has a days inventory outstanding of 58 days, and that's a very solid boost to cash flow because inventory is cash tied up. You have to build a product, you have to move it, you have to store it, to get into a store, and then you get paid and collect the cash. So this is an excellent metric to see if a company is walking the walk. And we can tell in this case that P&G is certainly walking the walk.
Some other metrics you can look at include the cash conversion cycle, which, again, is maybe effective to look at but might be more difficult to find. But if you want one which is easy enough to locate, look at a company's operating cash flow. Procter & Gamble again is sacrificing some top-line sales in order to trim its brands. That means some brands will disappear; it won't be selling those on the marketplace. But if you look every quarter going forward at the amount of operating cash flow Procter & Gamble generates, if it's being successful, that number is going to grow every quarter here on out. I love to look at that when I know companies are trying to become more efficient with their resources. And these two concepts are tied together. The company cycles its inventory more quickly, it should produce more operating cash flow.
And so far what we're seeing is it's a good thing that Procter & Gamble has undertaken this initiative so long-suffering investors have seen that stock for many years just remain stagnant. It's finally, I think, getting a little bit of lift from these operational efforts.
Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.