After joining Procter & Gamble's (NYSE:PG) board of directors in March (after a protracted proxy battle), billionaire investor activist Nelson Peltz has had a little over six months to acclimate and start pushing for change. Is he pushing in the right places?
In the following Industry Focus podcast segment, we run down and analyze Peltz's initial punch list for the consumer staples giant.
A full transcript follows the video.
This video was recorded on Sept. 25, 2018.
Vincent Shen: Our next company is Procter & Gamble. Specifically, we want to look at the company and the impact that activist investor Nelson Peltz has had since joining the board in March of this year. That whole process was its own epic saga that we talked about last August. When we last covered this news, Peltz and his firm, Trian Partners, were angling for a greater say in the company's future by this big proxy battle. Supporting their push was the fact that even though Procter & Gamble has been in this multiyear reorganization, they've reduced their brand portfolio by essentially two-thirds from over 200 brands to less than 70, the company's still putting up weak growth for the remaining business lines. A lot of people look at Procter & Gamble, the fact that it's a dividend king. They've been growing their annual payout over 50 years. But its total return performance in the past decade has really lagged the broad market and the competitors.
Again, Peltz took a place on the board earlier this year. To address that underperformance, his fund, Trian, suggested several changes. Asit, can you walk us through some of their major suggestions?
Asit Sharma: This goes back to the original white paper, the argument for Peltz joining the board, which was in the fall of 2017. This summer, as Vince alluded to, the company regained some ground. The stock was down almost 24%, it's down about 8%. This is after Nelson Peltz told a conference in the industry that the company was considering his proposals.
The major point of the proposal is to organize Procter & Gamble in a way that promotes accountability. He wants the company to be organized basically into three stand-alone units. The first would be beauty, grooming and healthcare. That would have about $26 billion in sales. The second would be fabric and homecare, which would be $21 billion in sales annually. The third would be baby, feminine, and family care, which would have about $18 billion in sales.
The company as its structured now has separate marketing units, sales units, from its many divisions. Even though it's whittled down its total number of brands, as Vince just mentioned, down to about 70, it still has a very complex organizational structure. Peltz wants to really whittle that down. If you read between the tea leaves, this opens it up to maybe separating those divisions, maybe spinning off the weakest division in a few years and. That's a hallmark of the activist investor. Simplify the company structure, then spin off divisions, make them their own publicly traded company, usually with a tax advantage in doing so, which rewards shareholders.
The rest of the points didn't get quite as much publicity, but I want to read through them. They're important for current investors to note. The second point is to ensure management's $12-13 billion productivity plan delivers results. If you're a longtime shareholder of Procter & Gamble, you have probably wondered, "Why do I keep hearing every two or three years about this multibillion dollar productivity plan? The stock never really seems to get a benefit from this. When I read the financials, the margins look the same." Peltz says it's all well and good that the company has engaged in the cost-cutting endeavors that it has, and it's worked on its supply chain. But you have to see bottom line results. You have to see top line results from the greater efficiency, which drives more sales volume. He wants to hold management accountable to this moving target of multibillion dollar productivity plans that take place over several years.
The third is to fix the innovation machine. Peltz has long argued that Procter & Gamble is broken and that it hasn't come up with a major new brand, by his count, in over a decade. The one quibble that investors should have with that is that Procter & Gamble has had a tremendous amount of innovation, but it's focused that innovation on packaging. Tide Pods is probably the easiest example to recognize. This was a market that Procter & Gamble created by itself, simply taking its detergent and repackaging it in a new formula. It sold billions of dollars worth of that product. But what Peltz argues is, you've got to come up with new brands. Your innovation machine can't be focused just on packaging alone.
The fourth point is develop small, mid-sized, and local brands. Anyone who shops is familiar with the disruption that's going on in retail. With fewer visits to the grocery store and more opportunities to order stuff online or have it delivered to your house, you don't have that visual read through on the grocery shelves where many of Procter & Gamble's products sit, whether those be grooming or beauty, what you would normally see in your weekly cycle of buying groceries. That's getting disrupted. Peltz argues that without buying up small innovative brands that you might buy through an alternate channel, Procter & Gamble's missing out on a huge opportunity.
I wanted to point out that the giant rival of Procter & Gamble, Unilever, has actually been pretty savvy at snapping up these small and mid-cap companies over the past couple of years. By my account, they spent about new $9 billion. Management says that this new portfolio of smaller companies, most of them have a sustainability bent. They have a local focus. They return about 16% annually per investment dollar spent on these. It's working out for Unilever. Peltz argues, "Procter & Gamble, you need to start ramping up the M&A and jump in this game, as well."
To that next point, he says, make M&A a growth strategy and a core competency. We will grant that Procter & Gamble has made at least one natural products acquisition in the past year. It bought manufacturer Native Deodorant for $100 million cash. This was last November. But it has not really jumped into the mergers and acquisition game as it probably should.
Sixth point is win in digital. We all know what that means. Procter & Gamble does have a good outreach in digital commerce. But Peltz will point out that companies that he's been involved with in the past have spent more and really researched more innovative ways than Procter & Gamble has engaged. He wants them to ramp up digital spending to get to the consumer who isn't going to those retail outlets.
The last point is, address the insular culture. Personally, I have written a lot about Procter & Gamble's tendency to simply repurchase shares and issue dividends with the massive amounts of cash that it generates. If you take a look at the company's balance sheet, it's always slightly heading toward that moderate to high leverage, and current liabilities are always outweighing current assets. With such a big fortress-type balance sheet, the company has really done little to invest, in my opinion, in radical strategies to innovate and grow at sales. But it returns a heck of a lot of money to shareholders.
I think that one of the things Peltz is getting out in this idea of addressing an insular culture is that there is no skin in the game for management. There have not been hard consequences for underperformance. The stock has been flat for several years, and it's coasted on this formula of selling its brands in the marketplace, buying back a lot of shares, issuing dividends, being that safe widows and orphan dividend-issuing stock. He wants to break that up and bring out more people from the outside to fill the ranks of P&G's middle management, with folks who have been in rotations at other companies.
Last thing I'll say is, Procter & Gamble is famous for moving people up in its own organization. That is definitely a positive, in terms of performance among individual middle management and executives, as they move into higher management. The problem with that is that you do tend to have a dearth of ideas from the outside. Trends can upend you, and you don't see them coming. This is one of his primary arguments on why the company has underperformed. It's really had its head in the sand, in his opinion.