Procter & Gamble (NYSE:PG) investors have had to wait years for the consumer products giant to execute on its turnaround. But as management hopes to make major progress going forward, one major shareholder is done being patient.
In this episode of Industry Focus: Consumer Goods, Vincent Shen and senior Fool.com contributor Asit Sharma talk about the growing tensions between Nelson Peltz, billionaire activist investor, and the P&G management team.
The team also covers major developments at the box office as the summer blockbuster season comes to a close. Ticket sales are down from last year, and some investors in the industry are paying dearly.
A full transcript follows the video.
This video was recorded on Aug. 15, 2017.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and it's Tuesday, Aug. 15. On the docket for this episode is an activist investor putting pressure on a major consumer products giant. We'll also look at some trends from the box office as the summer blockbuster season winds down, and how that's affecting some companies in the industry. Joining me today via Skype is senior Fool.com contributor, Asit Sharma. Hey, Asit! Thanks for being here!
Asit Sharma: Hey, Vince! As always, it's great to be with you!
Shen: Yeah. We have two really good topics today to talk about. The first one, it's always interesting to see how activist investors and major shareholders can influence the goings-on at a company. Let's set the stage for our first story. 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?
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.
So turning now to our second topic for today, we are just two weekends away from the end of the summer blockbuster season, which starts in May and wraps up with Labor Day. So far, results are looking weaker for some of the many franchise installments and reboots and superhero movies that have hit theaters this season. But before we dive in, Asit, what were the last couple movies that you actually saw in theaters? I'm just curious.
Sharma: I'm going to confess, maybe some of our listeners will remember from a podcast several months ago, I've had my head buried in books this year. It's the first year in a while that I haven't been to a theater and seen a blockbuster film. I will say, though, my oldest son, his latest film was Baby Driver. He and his friends saw that together, and he's been playing songs from the soundtrack. It's excellent. So I'm definitely going to see Baby Driver, and as a family, we're going to get to Wonder Woman before the summer. I can tell you what's on our slate to see. How about you, Vince? What have you seen this summer?
Shen: The last movie I saw in theaters was Atomic Blonde, which was very good, kind of a movie that I think they were hoping would ride off the popularity of the John Wick series. But I think what you mentioned in terms of not really making it to the theaters recently, points to some of the bigger picture trends that we might touch on here. I'm curious, to follow up, you mentioned that you want to see Wonder Woman, you want to have a family outing at some point. Are the theaters that you usually have in mind now for that kind of experience your standard first-come first-serve kind of theater? Or is it one of the newer operations where there's assigned premium seating, you might be able to get more food and drinks as well with the movie? What do you guys lean toward in terms of that experience?
Sharma: We're a family of five, so we tend to be pretty budget-conscious. I live in Raleigh, North Carolina, and we have a number of new film theaters popping up. The experience of going and having that premium seating and food, it's something that my teenage sons are all interested in, but as a family, we still catch the matinee when we can. We try to go to a nicer, newer theater. Raleigh has a great panoply of vintage theaters, mainline theaters, which are in good condition, renovated theaters, and then this upper premium type of experience that you're talking about. So, for us, family of five, we're going to hit the matinee at one of the major chains. AMC (NYSE:AMC), Regal, that type. Throw it back to you, what type of theater are you going to these days, Vince?
Shen: In the city here in D.C., there's a few different options, from your standard first-come first-serve to the smaller theaters with maybe just 25 seats, where it's assigned seating, very plush, more of a premium experience.
But ultimately, going back to what you mentioned in terms of this being one of your first trips to the theater for this year, if we look at this industry from a 10,000-foot level and start drilling down, the big thing to keep in mind is that ticket sales volume has been going down year after year, but rising average ticket prices are able to prop up some of the total box office receipts. On the one hand, we have moviegoers like you who haven't made it in for a long time, maybe just not that happy with the slate that's out there. On the other hand, I really like going out to see movies, and I'm kind of helping to prop up that average ticket price, paying a little bit of a premium for an IMAX film to see Dunkirk, for example, or to get that assigned seating. But so far in 2017, to give our listeners an idea of what's going on, Asit, can you give us a quick rundown of the industry revenue year to date, and some of the big titles that have been leading the box office?
Sharma: Sure. I gathered some data from Box Office Mojo, which is a great source to go to if you want a quick view of what the movie industry is doing. The domestic industry, the gross box office receipts to date as of Aug. 13 are $7.18 billion. That's about 4.3% off last year's pace. That's a significant drop off when, as you said, Vince, you have to have both ticket sales and these increasing receipts, increasingly expensive ticket prices, to maintain a similar take as the last year.
Places were led by Buena Vista, which is Disney Studio, Beauty and the Beast, of course, $504 million year to date. No. 2 is that film that I want to catch, Wonder Woman, $402 million. Now, I'm going to read for listeners the next three for a reason. There's Guardians of the Galaxy, it's $389 million take year to date; Sony's Spider-Man: Homecoming, which is $306 million; and Despicable Me 3, which is Universal's film, $248 million. If you add these five films together, you come up with $1.85 billion, and that's 25% of total box office receipts to date this year. So five films make up one-quarter of total receipts.
I was surprised to see this when I came across the stats, because you hear, if any of our listeners hear box office receipts through the year on public radio, or read about it in the paper, that this industry depends on blockbuster films -- that's, in large measure, true. A certain part of the revenue, in fact, the foundation of it, is built on just a few films each year. One film can make a difference between that 4.3% we were just mentioning from the prior year, which surprised me. I don't know, Vince, if that's something you were familiar with, or took you by surprise as well?
Shen: I think the big thing to note is, the first movie, Beauty and the Beast, the second one being Wonder Woman, and then the other three were all sequels, franchise installments. But, the idea being, these are all established properties and IP that are able to get audiences into theaters. Once again, we have Walt Disney leading the major studios in the box office, in terms of box office receipts. It was the same in 2016. Universal and Warner Brothers are trailing closely. Though the summer season has been particularly weak, the actual results, as you mentioned, are only off from last year by about 4%.
But if we look past the studios, from more of an investing perspective, it's really interesting to see the box office down 4%, but three major theater chains are all in the red in terms of their share prices for 2017, some of them quite a bit so. Can you give us a quick rundown on what's going on with the big theater operators out there?
Sharma: Sure. AMC, this is the one that's going to surprise everyone, it's down nearly 60% year to date. Of course, if you own it, that won't surprise you. You'll be familiar with that already. Cinemark down 18%, and the stock price of Regal Cinemas is down roughly 6%. I'd like to focus on AMC because, if you read the headlines about movie receipts and you're a shareholder and see the company has punched 60%, you might be tempted to say, "This is really pretty bad, this drop off in the box office receipts. What happens if we have a down here next year? Is my stock going to zero?" Let's dig in.
AMC has had an ambition to grow, and they've become the largest domestic theater operator. I think they're also, at this point, the world's largest theater operator. They've got now a thousand theaters with 11,000 screens in 15 countries. But they did this in large measure by making three major acquisitions over roughly the past year. One that our listeners will be familiar with is Carmike Cinemas. In making these acquisitions, AMC has leveraged its balance sheet. It's got now about $4.3 billion in debt. And that interest expense paying on that debt is part of the financial equation which propelled them to a $176 million loss last quarter. So a combination of lower receipts and this leverage is hurting maybe what is an over-ambitious chain for now.
I don't know, Vince, if you follow AMC or had a chance to look at this stock. What are your thoughts about this interplay between the receipts and what the company has done to become this leading theater operator? Is it worth it?
Shen: That's a tough one for me. If you're an investor in these theater operators, something you'll know, and if you're not, something you have to keep in mind is, is that you kind of fundamentally don't have as much control over the product that you're selling. The studios are the content creators and driving that part of the equation. But these companies, a lot of their bottom line comes from the perks that they sell you in terms of the concessions and in terms of the experience, whether it might be with 3D viewing, with IMAX, with premium seating or whatever it may be.
Another company, similar, that has struggled this year like AMC and is in a similar position is with IMAX (NYSE:IMAX), which is down 40% year-to-date, some of its lowest levels in the past five years. The company is laying off employees. Ultimately, they're similarly feeling the pain from the poor trends in the industry. For example, near-term headwinds like 3D losing its popularity, and the fact that revenue from 3D ticket sales, for example, has declined steadily from their high back in 2010, and in general, losing their share of box office revenue, at least domestically. A company like IMAX still depends on expanding into more theaters for growth. But then you have some of the operators like AMC looking to other perks like concessions, seating, as ways to bring in theater-goers, rather than upgrading their screens to IMAX. So there's all these different players here in this industry, and it's interesting to see how they deal with what, right now, is a 4% off year, but a very slow summer season. And that timing, I think, for AMC, has hurt them particularly, as you mentioned, as they've made these three large acquisitions.
But looking out further, I think we've had episodes in the past where we talked about competing entertainment alternatives, the fact that ticket sales do go down year after year, and a lot of people are ready to start writing the obituary, to an extent, on the idea of people going out to see movies. But, I think if you're even looking out 20 to 40 years, barring some crazy technological innovation in terms of how people consume movies, I think this is a long-term, sustainable business, and these theater operators and the contact creators, as well, will be able to adapt and make things work. A lot of people might think that theater operators, that their space is fading. But overall, they find their ways, whether it was through 3D or IMAX or other things like concessions, to bounce back and keep their growth going.
Sharma: Yeah. I just want to make one quick point, I think it's an excellent point and I just want to reiterate that, I also believe that over the long-term, this industry is going to continue to grow. They'll find ways, like the premium concessions, premium seating, to adapt. At the end of the day, it depends on the content, and that comes in waves. Sometimes the content is great and movie receipts are awesome for three years running, and sometimes you have an off year. But as humans, we love to get out. At the end of a long week, there's almost nothing more fun if there's a great film in the theater. I'm thinking ahead to, actually, The Last Jedi, for example. I can't wait to see that film. So we have to get out and have this experience of going to the theater. It's so much fun, and I think this industry is going to be around. I think AMC will overcome its near-term problems and also IMAX. Although, this year, you haven't been very happy to have been holding these shares. But they'll recover, and the industry itself is going to do well in the long term.
Shen: Yeah. For a company like IMAX, we've seen it in the results in the past, for example. It can be a single huge hit that can shift all of their prospects, and their results for a single quarter. It can have that much of an impact, in terms of just a single title. So the volatility is there and not ideal, but it's not necessarily a deal-breaker, in my opinion. That wraps up our discussion for today. Thank you, Asit, for joining us. I will definitely follow up with you once we have updates on the situation with Peltz and the Procter & Gamble team.
Sharma: Awesome, sounds great.
Shen: People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thank you for listening and Fool on!
Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends IMAX, PepsiCo, and Walt Disney. The Motley Fool has a disclosure policy.