Can Break-Up Unlock Hidden Value in Procter & Gamble Co (NYSE:PG) Businesses?

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Spin-offs have been a common subject across the consumer industry, including actual deals for Altria Group Inc, Dean Foods Co (NYSE:DF), Sara Lee and speculation for other firms, including PepsiCo, Inc. (NYSE:PEP). Here in this article we will discuss whether if operated separately, can Procter & Gamble Co (NYSE:PG) businesses record improved profitability.

Turnaround mode

Procter & Gamble is in turnaround phase whereby the consumer firm is trimming away its non-profitable or less profitable brands to focus more on its power brands. The company, priced at a fair valuation, distributes a dividend payout of 3.5% while investors wait for the turnaround to record results.

Many of the company’s problems can be linked, indirectly or directly, to misguided application of strategies across a rambling. This has resulted in the concept of a spin-off to the forefront. However, it is important to understand that company had to pay a cost to attain growth after a spin-off.

Why spin-off?

There are two main reasons why we are discussing about the prospect of Procter & Gamble spin-off. The first reason is the company’s shares have underperformed the market over a protracted period. Its share price has lagged the peer Consumer Staples by 87% and the SPX by 109%. More precisely, the company’s stock has underperformed its peers by almost 20% so far this year.

The second reason Procter & Gamble spin-off can be a probable outcome is the slow growth and lower margins. So far in this year, the results have failed to demonstrate the benefits of scale.

The financial performance

In the third quarter earnings report, Procter & Gamble reported that its total sales declined 12% following the exit of the company from many businesses and adverse impact of foreign exchange on overall performance.

With nearly 60% of the company’s sales coming from outside the United States, adverse currency effects hurt revenues by nearly 9%. Overall, portfolio transformation strategy, brand divestitures and adverse currency effects have adversely affected revenue. Core operating margin surged 320 basis points on a current neutral basis while gross margins were up by 40 basis points to 50.7% in the last quarter. The segmental revenue growth came at Personal Care/Beauty/Hair at 12%, Grooming at14%, Health Care and Home care both at 11%, and Feminine/Baby was12%.

Base case

A spin-off would require to be justified by the benefit of renewed competitive spirit, greater agility and streamlining decision making, creating a less risk-averse and more entrepreneurial culture. Thevalue of these intangible elements surpass the inherent costs, explicitly including tax drag and dis-synergy. There can be a number of different break-up scenarios, but a spin-off the company into five entities along current segment lines, would lead in operating dis-synergy of nearly 1% of total sales.

This estimate includes stranded overheads, incremental public company costs, net of a better abilityof a smaller, more agile firm, to support cost savings. Further, presuming the average tax rate of the spin-off entities reverts back toward 30%, there will be a 600 basis points of tax rate drag.

Bottom-line

Procter & Gamble has been in the midst of its strategic plans of focusing on its core brands and shunning non-profitable brands so as to establish a faster growing, profitable and easily manageable firm. The company has been executing its portfolio simplification and strengthening plan to focus more on largest core brands and streamline its operations. So far, it has divested nearly 60% or almost hundred brand that were witnessing profit and revenue drop.

In addition, the company plans to cut expenses by reducing costs, streamlining managementand cutting jobs under anearlierreported 5-year, $10 billion restructuring plan. It suggests the company can perform better without opting for a probable spin-off. Procter & Gamble will succeed with its plans of cost containment and divestiture of lesser brands to create value for shareholders for years to come.

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