Another Act in the P&G-Peltz Drama

Even though

Peltz has suggested that P&G’s organizational structure, corporate governance, and recent financial performance have lagged those of peers and that more must be done to accelerate the pace of change at the leading household and personal-care company. However, we think P&G has been pursuing a course over the past several years to right its ship, culling unprofitable brands and extracting excess costs. While these efforts have yet to materialize as sustainable improvement, we view the company’s efforts as sound and don’t believe that merely adding Peltz to the board will bring forward a meaningful uptick in performance.

The challenge in assessing the election results lies in the fact that shareholders can vote as many times as they wish during the proxy contest, but only the last vote is official; as such, it is likely the outcome could remain unknown for another few weeks. This does little to alter our $96 fair value estimate, which is based on our expectation for 4% annual sales growth in the longer term and 300 basis points of operating margin expansion to nearly 25% at the end of our 10-year explicit forecast. We view the shares as modestly undervalued.

Whatever the ultimate outcome, we expect P&G management will be held to task to deliver on its strategic agenda. We think much attention over the next several quarters will center on the company’s top-line trajectory, where sustainable gains have proved particularly elusive in the recent past. In an effort to drive improvement, Procter & Gamble is focused--rightly so, in our opinion--on extracting excess costs, with targets to eliminate another $10 billion in costs (a high teens percentage) by reducing overhead, lowering material costs, and increasing manufacturing and marketing productivity. We view this as achievable.

We believe that rather than merely bolstering profitability, the company will prudently direct these savings to fuel further investment behind its brands, with a bent toward bringing value-added innovation to market and touting this fare in front of consumers. We forecast the company will allocate 3% of sales to research and development and 11.5% of sales to marketing annually, up from historical levels of less than 3% and around 11%, respectively. While we stand by our contention that the path to sustainable sales gains will prove lumpy, we still believe that the benefits from the company’s enhanced focus--after shedding more than 100 brands from its mix over the past three years--will drive increasing sales and volume growth and aid the brand intangible asset source underlying Procter & Gamble’s wide economic moat in the longer term.