Procter & Gamble (NYSE:PG) has one of the best long-term reputations on the market, but it's really lagged in performance in the last five-to-10 years, which has drawn the attention of activist investor Nelson Peltz from Trian Partners.
In this clip from Industry Focus: Consumer Goods, host Vincent Shen and contributor Asit Sharma explain why Procter & Gamble has lagged the market so much in the last few years, what Nelson Peltz is proposing to do about it, how Peltz and Trian Partners are getting their hold on Procter & Gamble's company and voting processes, and how this could change things for Procter & Gamble going forward.
A full transcript follows the video.
This video was recorded on Aug. 15, 2017.
Vincent Shen: The major consumer products company I mentioned earlier is none other than Procter & Gamble, ticker PG, a $230 billion behemoth that has a very impressive portfolio of leading household brands, including Old Spice, Crest, Tide, and Pampers. For any Fools who don't follow this company, it's important to know that even though Procter & Gamble boasts about 65 brands right now, that's after the company divested itself of 100 others in a multi-year effort to streamline the business.
If you look back 20 or 30 years, PG has been a very good stock for investors, with market-beating returns, and that includes the legendary dividend. I say legendary because Procter & Gamble is not only a dividend aristocrat, but a dividend king, meaning the company has increased its payout annually for over 50 years, so very impressive track record. But if you look back just five or 10 years, the results are not quite as encouraging. The stock has lagged the S&P 500. Obviously revenue on the top line is down with its various divestitures, but other important metrics like profitability and market share are heading in the wrong direction, too.
That leaves us with this recent news regarding Nelson Peltz. He's the CEO and co-founder of Trian Partners. Peltz is a pretty well-known activist investor. In the past, he's made moves on companies like DuPont, PepsiCo, and Wendy's. Asit, what is Peltz fighting for right now?
Asit Sharma: Vince, Procter & Gamble is this classic stock which, in the old days, we used to call a "widows and orphans stock", meaning that it was so safe that even widows and orphans could put their money in and collect the dividend and be very happy with the stock appreciation. That may be politically incorrect in this day and age, but it gives you a sense of the history, how old this stock is, and how well it's done over the decades. But again, this 10-year period, tracking returns of Procter & Gamble versus the S&P 500, total returns, Procter & Gamble up 96% over the 10-year period, the S&P up 115%. Every time frame that I compared leading up to today to do some research -- five-year, three-year, one-year -- Procter & Gamble lagged the market on the total return basis.
And this is what Peltz's biggest gripe is, that this company, which has divested itself of over 100 brands, should be growing again. The purpose was to slough off all those low-growth brands and put money into ones that will grab market share. Procter & Gamble really hasn't been able to grab a lot of market share. They have a great mindset for stability, which is, the management team loves to pay out those rich dividends, and also repurchase shares. It's a very strong cash flow operation. Last year, the company gave shareholders a $22 billion return between share repurchases and dividends. But that hasn't really translated into stock price movement. And this is where Nelson Peltz, who's an expert at agitation and provoking management teams to deliver value to shareholders, sees an opening. He wants to go and shake up the management and their worldview, to go from this type of stability mindset to an innovation mindset, a market share aggression mindset, a sales growth mindset, which just hasn't characterized the management team over the last 10 years.
Shen: Yeah. Peltz right now is encouraging shareholders to vote and help put him on the board of directors to help guide the company in the direction that fits his vision for growth and innovation that you mentioned. His fund has really ramped up their holdings of Procter & Gamble, really just in the first half of this year. End of year 2016, they only owned about 6 million shares of the company. As of the fund's latest filing for June 30th, we can see that Peltz holds a stake of 37.6 million shares. That's a market value of about $3.4 billion. While this position makes up about one-quarter of the entire fund's portfolio, in terms of the stake of the overall company, it's only about 1.5%.
As part of this battle with management right now, he has a website up with the URL www.revitalizepg.com. There, you can find a lot of information on Peltz's fund, his problems with current management. There's a pretty slick presentation on there as well that addresses everything from Procter & Gamble's weak returns in market share, some of the organizational lack of flexibility, and why and how Peltz thinks he can help the company. So what do you think might be some of the broad strokes that Peltz lays out to boost growth and boost the results at the company?
Sharma: First, I want to say, listeners, this website that Trian Partners just launched sounds a lot to me like it could be the next big laundry detergent brand for PG -- Revitalize, revitalizepg.com.
Peltz has an idea, the three avenues he's looking at. His idea is, shareholder returns have been weak, we want to attack that. The company has deteriorating market share, we want to attack that problem. And then, there's the excessive cost in bureaucracy. So he's signaling that he will have focus on product innovation and also the cost structure. Now, it's worth noting that Procter & Gamble's management team has already cut $10 billion out of its cost structure, but the company is so big, this hasn't meaningfully affected their net income. So Peltz will argue for further cuts, but he will also seek innovative ways in which the company can produce that value.
One thing that Peltz is extremely good at is pushing spin-offs. In fact, he has a very famous failed example in Mondelēz, which is the company which was spun off from Kraft several years ago in 2013. He got a seat on their board and started advocating that Mondelēz should itself merge up with PepsiCo's snack division, which is Frito-Lay. So he wanted to break PepsiCo apart into a beverages and a snack company, and have Mondelēz merge with Frito-Lay. That actually never happened, but his presence on that board created a lot of positive pressure in that management of Mondelēz has become even more attuned to pushing their idea of what they call power brands, which is focusing on the brands with the most potential with already the biggest market share, and pushing those to grow more quickly. So I think there are many ways that he can achieve these objectives of getting market share and hitting the cost structure. But one thing that shareholders might see if he's successful and getting a board seat is this idea of spinning off a division.
Shen: My take when I started going through this news and doing my research for the company and all of the efforts that it's gone through to streamline its business, ultimately, Procter & Gamble has only recently completed its strategic divestitures. I think, when Peltz made public his criticism of their recent performance and his aims for the company, management did fire back with its own press release, pointing to some of the things the company has achieved and lots of other opportunities to operate more efficiently, talking about things like reorganization, reducing expenses, as you mentioned, their $10 billion of cost cutting efforts, the company expects to cut as much as another $10 billion over the next five years.
But I guess my question here is, do you think it's fair to argue that maybe it's too soon to say these efforts are failed? That Peltz is maybe jumping the gun, that despite the weak returns that we've seen over one, three, five-year periods, the divestitures of those 100 brands, for example, only recently completed, that management needs more time, maybe another year or two to execute on the turnaround? The margins for this company are still quite strong for its industry. And as you said, it's a cash cow, it generates plenty of capital to return to shareholders. Should the company have another year or two maybe to show improving results before an activist investor like this jumps in and really shakes things up?
Sharma: Personally, I think you have a point. P&G has a relatively new CEO. David Taylor has only been on board for a few years. And this whole divestiture move has taken place over the last couple years. So there's very much one point of view which says, look, it may take two to three years, but if you're patient with P&G, they could see some appreciable returns from the strategy of divesting from those brands that made up a very small part of the profit and focusing on what really drives the economic engine of Procter & Gamble.
But this is the nature of activist investors. They rarely seem to come in at the right time. They often come in at a time which catches everyone off guard. I think this is the nature of how they attack. We should mention that this battle of the press releases has evolved one step further in that Trian is actually waging a proxy battle now. They're asking the shareholders to vote because Procter & Gamble's management obviously wants to do just what you suggested, which is, "Let's see if our investments bear some fruit. Give us a chance to breathe here, we just completed these major divestitures in sales, and we're focused now. Don't come in at this point, right when we're beginning to see the fruit of our strategy." So it's up to the shareholders now to vote whether Peltz can obtain a seat on the board or not. And it's pretty quickly moving into that acrimonious juncture we've seen many times between activist investors and the board and management team which feels very confident in what they're doing. So it'll be interesting to watch as we go forward, for sure.
Shen: We'll definitely continue to follow the developments from this back and forth between Peltz and management. I think that even if Peltz ultimately fails to win a place on the board like he hopes, something that you alluded to earlier, Asit, is the idea that he's leaning on management now to basically show the shareholders some progress, and put some pressure on them to take steps that they wouldn't otherwise, without this pressure from outside of the company. I would argue that, maybe for a large, less nimble organization like Procter & Gamble, with the scale and size they operate at, that's not necessarily a bad thing, and it could result in some positive developments for the company and its investors.