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Copyright © 2008 by Brian Gaudet, All rights reserved, including the right of reproduction in whole or in part in any form

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Procter & Gamble

1 Analysis (last updated end of FY08)

Business Summary

Proctor & Gamble develops, manufactures, and sells consumer goods. Primary saleschannels are mass merchandisers, grocery stores, membership club stores, and drugstores, Proctor & Gambles products are sold in over 180 countries. The company’sbusiness segments are described in the table below:

Segment Products Key BrandBeauty Cosmetics, Deodorants, Hair Care,

Personal Cleansing, PrestigeFragrances, Skin Care

Head & Shoulders, Olay, Pantene,Wella

Grooming Blades and Razors, Electric HairRemoval Devices, Face and ShaveProducts, Home Appliances

Braun, Fusion, Gillette, Mach3

Health Care Feminine Care, Oral Care, PersonalHealth Care, Pharmaceuticals

Actonel, Always, Crest, Oral-B

Snacks &Pet Care

Pet Food, Snacks Iams, Pringles

Home Care Air Care, Batteries, Dish Care, FabricCare, surface Care

Ariel, Dawn, Downy, Duracell, Gain,Tide

Family Care Baby Wipes, Bath Tissue, Diapers,Facial Tissue, Paper Towels

Bounty, Charmin, Pampers

Revenue by Geography

United States40%

Intl. Developed

30%

Intl. Developing

30%

Revenue by Segment

Beauty23%

Grooming10%

Health Care17%Snacks

6%

Home Care28%

Family Care16%


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Segment Beauty Grooming Healthcare Snacks Homecare FamilycareOPM 19.0% 25.4% 24.8% 15.6% 21.2% 28.2%ROA 26.1% 28.6% 68.3% 33.1% 63.5% 31.5%

Operating History (3.2)

Ten Year Operating HistoryROAA OPM RORE RORE+D GM InvTurn E/FCF E/E+D-C28.0% 18.7% 15.3% 10.0% 48.2% 5.8 0.93 0.91

3.5 2.7 3.3 <- RatingROAA: Return on Adjusted Assets; OPM: Operating Margin; RORE: Return on RetainedEarnings; RORE+D: Return on Retained Earnings & Change in Debt; GM: Gross Margin;InvTurn: Inventory Turnover; E/FCF: Earnings to Free Cash Flow; E/E+D-C: Earnings toEarnings+Depreciation-Capex

Organic sales growth was 6% from 2000-2007. Earnings grew from 1972 to 1997 at anannualized rate of 13.9%; this period covered multiple recessions, two of them severe1.Over the same period, the SP500 had an annualized EPS growth rate of 8%.

Future Prospects (3)

Procter & Gamble competes through differentiation, and spends heavily on research anddevelopment to create products that are differentiated from that of competitors, andspends heavily on advertising to signal the value of the company’s brands. Due to theirrelationship with many retailers and investment in learning about consumer behavior,P&G has a good sense of what consumers want in a product, and can effectively focusresearch and development to create new products, and improve existing products to bettermeet consumer needs. P&G is decentralized, with global business units focused onindividual countries. This cuts overhead, and more importantly, lets the business unitoptimize operations for a particular country. The combination of global scale and localfocus enhances the company’s competitive advantage.

Buyer Bargaining Power

1 From Jeremy Siegel’s “Stocks for the Long Run”, chapter on nifty fifty.


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A high absolute value of research and development spending allows the development ofproducts that actually do add value over the products of rivals, and high spending onadvertising facilitates the signaling of this value. Some examples:

• Detergent optimized for cold water washing (saves energy costs)• Detergent optimized for single rinse (where clothes are washed by hand)• Compact detergents to reduce packaging waste

P&G’s three tiered product line helps with pricing power, as the lowest tier acts as a pricebenchmark for customers deciding whether the higher tiers are appropriately priced.

There is some retailer concentration, with Wal-Mart accounting almost 20% of sales. ButWal-Mart needs P&G about as much as P&G needs Wal-Mart, so their bargaining poweris not enough to hurt P&G’s profitability. If the company’s on-line sales channel growssufficiently (see under “Threat of Substitutes”) then this will give P&G additionalbargaining power with retailers.

Supplier Bargaining Power

Raw materials are primarily commodities, and are readily available from multiplesources. Labor is not organized, and is productive, with earnings per employee of close to$100,000.

Threat of New Entrants

Economies of scale allow P&G to spend much more than rivals on R&D and advertising.For example, P & G spends over twice as much on research and development than itsnearest competitor. P&G’s largest competitors by trailing 4 quarters revenue are Unilever($60B), Kimberly Clark ($19B), and Johnson & Johnson’s consumer segment ($16B).Only Unilever has the scale to come close to what P&G can spend on advertising.

Procter & Gamble’s advertising and R&D is spread over 44 brands that account for 90%of the company’s profits. There are many opportunities to leverage proprietarytechnology among multiple categories. P&G’s research and development is enhanced bya global relationship with nearly two million researchers in technology areas connectedwith P&G businesses. Moreover, these new products can be quickly brought to marketusing P&G’s existing brands and distribution system. P&G’s relative level of innovationis apparent from the results of the 2008 industrial research institute’s pace setter studythat measures the top new products measured by sales. In 2008, P&G had 10 out of 25 ofthe top new products in the non-food category. In comparison, Unilever, J&J, KimberlyClark, Colgate, L’Oreal, and Energizer collectively had 7.

Company 2007 Revenue R&D AdvertisingProcter & Gamble 83.5 B 2.2 B 8.7 BUnilever (in Euros) 40.2 B 0.8 B 5.3 B


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Kimberly Clark 18.3 B 0.3 B 0.5 BColgate-Palmolive 13.8 B 0.3 B 1.5 BJ&J Consumer Segment 14.4 B N/A N/A

P&G consistently cuts costs unrelated to differentiation, giving P&G a cost advantagethat acts as a barrier to entry. For example, continuous reformulation can provide thesame product performance with different ingredients, allowing the formulation to beoptimized for current commodity costs, and consequently saving on input costs. Theyalso have similar developing country margins as developed country margins, so theyapparently have a manufacturing system that geographically matches costs to the point ofsale. P&G saves on the costs of materials by creating purchasing pools for commonmaterials used over multiple product lines.

P&G’s distribution network reaches 800 M customers in China, 4.5M stores in India, and80% of the Russian population.

Threat of Substitutes

Private label goods are a viable substitute for branded products; however, P&G’s three-tier pricing can reduce this threat. If the third tier (lowest cost brand) is priced close tothat of private label products, and consumers prefer the tier 3 brand to the private labelproduct, then retailers will need to allocate a proportionally higher amount of shelf spaceavailable for the tier 3 brand, at the expense of shelf space for private labels, therebycreating a barrier to entry for private label manufacturers and other potential new entrantsto the industry. In their Q208 transcript, P&G mentioned that private label is not really anissue in developing world. Overall, it is not impacting P&G’s market share. In theirQ308 transcript, P&G mentioned that their products together with private label aregaining share.

A potential offset to the private label threat is the on-line sales channel, where thecompany can price their products closer to that of private label competitors and stillmaintain the same margins. Today, P&G sells diapers directly from their Pamperswebsite, and also sells numerous products on Amazon.com.

P&G sells the types of goods that are typically resistant to diminishing demand during arecession.

Intensity of RivalryNote that the industry follows the semi-log pattern of size that is associated with stability.The major competitors in the industries where P&G competes all have strong brands; thistends to diminish rivalry. In developing economies, the consumer goods industry isexpected to grow rapidly over the long-term; this will also reduce competition.


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Other Consideration

P&G continues to build manufacturing capacity in local markets. They also package andprice products optimized for developing countries, and distribute them in local storeswithin walking distance of consumers.

Major Risks

• Private label competition: P&G and branded competitors have opportunity tokeep margins high as long as collectively they provide more value than privatelabel competition. This will require continuous innovation. Over the last 13years, an IRI pacesetters study found that 1/3 of the most successful new productsover the 13 years have come from P&G, more than top six competitors combined.

Upside

P&G Sales per Capita

0

20

40

60

80

100

120

U.S UK Germany Mexico China India

Country

An

nu

al

Sale

s in

Do

llars

Despite P&G’s large market share, there is considerable room for growth as the globaleconomy expands, giving citizens of developing countries the ability to purchaseconsumer goods. P&G mentioned on their Q309 conference call that if per-capita use ofP&G products in India reached that of Mexico, it would add $20 Billion in sales.

Financial Strength (3.00)


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Credit Rating Ave. MaturingDebt to RE

Debt to Earnings Fixed ChargeCov.

Pension BenefitsPaid / PBT

AA3 0.76 2.82 10.5 4%

The largest risk here is the $16.5B in debt (net of $4.5B in cash) due within one year,which is less than P&G’s $13.6B in FY 2008 earnings. This is covered with $9B incommitted credit facilities expiring in 2012, which gives P&G flexibility in paying downshort-term debt if commercial paper markets freeze up.

Management

Summary

Future Prospects Financial Strength Operating History Combined Rating3.0 3.0 3.2 3.1

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