Procter & Gamble

Procter & Gamble (Ticker: PG)

Warren Buffett likes this stock. Should you?

In the corner of a meeting room next to the bosses’ office at the headquarters of Procter & Gamble (Ticker: PG), a large sculpture of a woman in a hat watches over proceedings with a serene smile. She is, it seems, at the center of all the group’s decisions. Founded in 1837 by William Procter, a candle maker, and James Gamble, who made soap, PG is the world’s biggest consumer goods company. It probably knows more about consumer marketing than any other firm on earth. Interestingly, many people at PG do not use the word “consumer”. Nor might they ask if a “customer” or “shopper” would buy a putative new product. They are more likely to ask: “Would ‘she’ buy it?”

Women have long accounted for four-fifths of PG’s customers. Over the years, the way PG sells to them has changed dramatically. In the 1930s it sponsored radio shows – the original soap operas – to encourage women (usually housewives) to buy its detergent. Now radio has been surpassed by television and the Internet as a means of promotion; and “she” has become ever more independent, demanding and fickle. The variety of products on offer has exploded, not just from makers of branded goods, like PG, but also from the big supermarket chains that now dominate the retail end of the business and sell their own labels alongside the big brands.

The consumer goods giant is spending lots to find out what she actually wants. Staff from its Customer and Market Knowledge division tour the world and spend entire days with women to observe how they shop, clean, eat, apply their make-up or put diapers on their babies. They try to understand how a woman reacts in the first three to seven seconds after she sees an item in a shop (the “First Moment of Truth”, in PG-speak) and when she tries it at home (the “Second Moment of Truth”).

At first PG struggled in the new world of empowered she-consumers. In 2000, after a big drop in profits, its share price took a tumble. Alan Lafley, a company veteran, took over that year (PG is a great believer in promoting from within). The company he leads has such a reputation for insularity that employees are known as “proctoids”, but Mr. Lafley has been trying to open up more to the outside world and to streamline PG’s notorious bureaucracy. He also needed a clear strategy for the company’s growth. That, he concluded, lay in investing more in the power of brands: the strongest brands, he reasoned, would be sought out by consumers everywhere.

Mr. Lafley began with the acquisition of Clairol, a hair-dye company, in November 2001. Two years later he paid $6.9 billion for Wella, a family-owned German beauty firm. But the biggest deal, in January 2005, was the $57 billion purchase of a company known for serving men rather than women: Gillette, which controls three quarters of the world market for razors and shaving foam. Has the huge Gillette purchase paid off? Mr. Lafley admits that he took a big risk. Four out of five mergers don’t work out, he says, and big deals fail more often than small ones. But he has a list of five reasons why mergers fail. On all counts he says PG is now doing fine.

And though PG gave a nod to the stormy economic winds yesterday as first-quarter numbers were released, it accepted only the merest widening of targets for the year ahead. While companies unable to predict the near future have characterized the reporting season, PG cut the lower end of its profits guidance by less than 1%. The group forecasts to produce earnings per share somewhere between $4.15 and $4.25 next summer.

Yet in spite of barely a raised eyebrow on the bridge, every sinew must be straining below decks. Input prices have fallen dramatically in recent months, but the time lag before manufacturers feel the benefit means PG still faces a $2.7 billion cost headwind this year. Currency volatility also makes life difficult – from boosting sales, PG now expects foreign exchange effects to take 1-2 percentage points off top-line growth this year.

At the same time consumers are “de-loading the pantry”, running down stocks of items such as batteries or razors, and waiting longer to buy replacements. (And there is no need to shave every day if you are not going to work.) A widening price gap between PG’s premium products and private label goods has also prompted greater trading down. How consumption patterns in emerging markets will change as rates of growth slow also remains unknown.

But the group is a master cost-cutter. Stripping out expenses related to selling, overheads and administration, moderated most of the hit to margins from commodities in the first quarter. Big, solid and diversified, PG should chug safely on. At $63.08, on a forward p/e of 14.88, the shares offer solid value.