Procter & Gamble (NYSE:PG) is beating the market so far in 2017, up 8% compared to the Dow Jones Industrial Average's 6% advance. The stock is steadily closing in on the all-time high of $93 per share it set in late 2014.
Investors have plenty to be optimistic about as sales growth speeds up and earnings get a major boost from cost cuts and a portfolio reboot. Yet caution flags remain for this struggling consumer products business. Here are a few good reasons to believe P&G's recent stock market rally won't last.
The slowdown in the consumer goods industry has been a major factor in P&G's uninspiring growth over the past few years, and there's little evidence of a significant global rebound gathering steam. In fact, rival Kimberly-Clark, which competes with P&G in the diaper market, recently projected just 2% organic sales growth in 2017 on the assumption that the challenging economic conditions that sank its 2016 results will continue.
Unilever (NYSE:UL) sounded a similarly depressing tone in January when it warned investors about a shrinking industry in developed markets and major economic challenges in key developing markets. "The tough market conditions which made the end of the year particularly challenging," CEO Paul Polman said in a press release, "are likely to continue in the first half of 2017" before hopefully improving later.
P&G executives were more optimistic in their latest results as they boosted their full-year outlook following two consecutive quarters of surprisingly strong gains. However, they're still projecting just 2.5% organic growth at the midpoint of guidance, compared to the 3% or better they achieved as recently as 2013. P&G's forecast could easily drift lower along with a weakening overall industry.
More market-share losses
P&G has improved the rate of its market-share losses lately, but it could easily continue losing ground to rivals over the coming years. There are major brand challenges to worry about here, including against the Gillette global shaving franchise from Unilever's online-based competitor, Dollar Shave Club.
There's also a more general threat from local rivals, including retailers that are dedicating more shelf space to their value-focused corporate brands -- and elbowing P&G's premium options to the side.
These hits helped push market share down in each of P&G's five core product categories last year. And while a brand-shedding initiative has left the company with a more defensible portfolio, the consumer products giant's business model requires that it grow at a faster rate than the overall market. P&G hasn't achieved that goal in roughly three years, and the stock isn't likely to return to its winning ways until investors see that trend change.
Procter & Gamble sees innovation as critical to its long-term growth. The ability to improve on existing products and launch entirely new categories "has always been, and continues to be, P&G's lifeblood," the company explains in its 10-K report.
Lately, though, the main engine of profit growth for investors has come from cuts -- from the brand portfolio and from the cost structure -- rather than innovative product launches. The good news is, P&G has raised tens of billions of dollars by selling off pieces of its portfolio and slashing inefficiencies. That cash has funded one of the market's most generous capital return plans, that promises to deliver $22 billion to shareholders this year alone.
Cost cuts aren't a long-term growth solution, however. And now that P&G has the portfolio that it wants, the company must start delivering the accelerated sales gains that management has been promising. In addition, it needs to introduce new billion-dollar products, the type that executives describe as "game-changing inventions that create new brands and categories." P&G hasn't released a major hit like that in a decade, and a continued innovation dry spell would sap returns for investors over the coming years in a way that the company couldn't offset through brand sales and cost cuts.