WHEN PROCTER & GAMBLE OPERATIONS CHIEF ROBERT MCDONALD is enthroned as chief executive July 1, what he doesn't do matters almost as much as what he does.
P&G 's biggest decision ever was its 2005 acquisition of Gillette, a $57 billion deal. Investors initially praised the huge transaction, citing the resulting behemoth's global potential in the face of consumer-product competitors like Unilever (ticker: UN). A dream for Warren Buffett, Gillette's largest shareholder, the purchase built P&G's (PG) beauty-and-grooming segment into a business that produced one-third of 2008 sales of $83.5 billion.
|Proctor & Gamble|
|Robert McDonald assumes helm.|
But the marriage doubled capital employed without doubling profit. The result? What seemed like a great idea "set back the corporate return on capital for a generation, and has held back the Procter & Gamble share price for years," says Andy Brown, chief executive of Cedar Rock Capital, a London investment-management firm.
The world's largest consumer-products maker, with 24 major brands ranging from Tide and Charmin to Crest and Head & Shoulders, the company now must continue to innovate through a tough recession in which consumer habits are changing.
Under the nine-year reign of CEO A.G. Lafley, P&G's inward-focused, proprietary culture opened up to permit partnerships with other companies so that promising ideas were tested more quickly than before.
McDonald told Wall Street analysts that he wants to "create a simpler, flatter and more agile organization" with lower costs and improved productivity. He is widely expected to winnow management layers and marketing budgets while expanding the empire.
P&G's international operations are concentrated in Europe with a lesser presence in Asia and Latin America. One obvious opportunity is India, where Unilever dominates and P&G has a small footprint.
At home, price wars and market-share erosion are inevitable for a company that is thought to capture 75% of American liquid-laundry-industry profits.
But even if the next year is a tough one, long-term investors should be optimistic. We would still be a buyer of P&G shares. (Barron.com, our Web affiliate, published a positive piece in February, "Buy P&G Shares Before They Crest.")
Brown started building a position in the shares earlier this year; the stock hit a low in March and has rallied 19% since. But there is still much to love: new direction at the top, and a share price that looks attractive, having fallen 15% so far this year to $52.55. P&G's dividend remains healthy at $1.76, for a yield of 3.4%. Smaller rival Clorox (CLX) last week raised its payout by 9% for a 3.6% yield.
Earnings look solid for 2009, with analysts predicting $4.22 a share. Not so for 2010, a year for investing and risk-taking, when profit could fall to $3.78 a share. That puts the stock at about 14 times 2010 earnings, in line with peers and a nice discount to its historic median multiple of 19.4.
"To the extent that [McDonald] has license to distinguish himself, the best way to compound value is to grow the businesses they have, not pay huge premiums," Brown says. "I would take a big acquisition badly."
-- Dimitra DeFotis
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