The Procter & Gamble Company (NYSE:PG) Goldman Sachs Global Staples Forum May 14, 2024 9:35 AM ET
Company Participants
Andre Schulten – Chief Financial Officer
John Chevalier – Senior Vice President of Investor Relations
Conference Call Participants
Bonnie Herzog – Goldman Sachs
Bonnie Herzog
All right. We’re going to start up again. So, up next, we have Andre Schulten, Procter’s CFO; and John Chevalier, Procter’s SVP of IR joining us on stage.
Now, prior to assuming his role as CFO in ’21, Andre was the SVP of Procter’s North American Baby Care Business, and has served in several key leadership positions at the company over his nearly 30 years of experience. Now, Procter has been one of the most resilient CPG companies over the past several years even as the industry faced a challenging backdrop with COVID-led supply chain disruptions, geopolitical tensions, record-high inflation levels, and a rising rate environment. So, really excited to have both Andre and John here to talk us through the secrets behind the company’s operational excellence as it navigated really through this volatile environment and its ultimately path forward. So, thank you again both of you for joining us.
Question-and-Answer Session
Q – Bonnie Herzog
And I guess, Andre when you sit here today, I wanted to ask you when you first looked at the company from a CFO’s perspective about three years ago, what in your view, was really working well, and then maybe what did you see as some of the areas of improvement that you ultimately identified?
Andre Schulten
Sure. Good morning, Bonnie. Thanks for having us. Look, let me pick up on the resilience point, because I think it’s true, the team has been able to deliver outstanding results I think prior to the pandemic, during the pandemic in an inflationary environment and obviously coming out of that inflationary cycle. And I think it’s all grounded in the execution of the strategy. If you think about the categories that we operate, we intentionally chose categories that are non-discretionary. They are daily use, and consumers value product performance. Consumers are willing to pay for products that actually deliver the benefit.
If you think about diapers, my previous job, you don’t want your diaper to fail, and if you get reassured that the diaper works, you’re willing to pay a few pennies more. Same is true for laundry. Same is true for fem care products. So, performance actually matters to the consumer a lot in these categories. And the team has done a fantastic job of building something we call irresistible superiority. And what that simply means is that across the dimensions of product performance, the way we package the product, the way it’s presented in store or online, the way we communicate the benefit to the consumer, and the way that we provide value to the consumer is superior to the next best offering in the market, and as we expanded that level of superiority from 30% in 2016 to 80%, you saw the business results go with it. They have been able, the teams have been able to deliver productivity even through the toughest parts of the supply chain crisis, and that is a core element of how we keep the cycle going, because that allows us to reinvest in superiority and drive that growth.
Looking around the corner, if you think about the developments of where the consumer was going, what we needed to do in order to be distributed in all the channels where the consumer would ultimately shop when value becomes a bigger topic for the consumer, and ultimately, we’ve got teams that are accountable, but they also have the decision rights at the right level, where they can drive the decisions that are relevant for their consumer. So, that strategy has worked. The best part about it, Bonnie, is it’s market constructive because it grows categories. That’s really the idea behind it.
Nothing in this company gets changed by one person, right? We have an incredibly capable group of sector CEOs and of market leaders, and when we looked at the company’s trajectory three years ago when John took his role, I took my role, we basically said there, the strategy is working. But there are a few things we want to double down on. And among those things were really redefining irresistible superiority. And the simple way to express that is we were looking at, are we superior versus the next best offering in the market, which is great. But if you think about the constructive nature of the strategy, we really want to be superior to the next best solution that the consumers are using and that keeps them from using our solution. So, when you think about a consumer who is using a mop and a bucket today, how can we make Swiffer so irresistibly superior for that consumer that they shift into the category? How can we make laundry users trade up from powder to single unit dose? So, that’s really the idea. How do we build irresistible superiority that more directly builds the category? And as we did that, we basically reset the superiority from 80% back down to 30%, illustrate to the organization that’s the new challenge that we want you to go after.
In sync with that, we increased the focus on productivity and most importantly, we decided to look at productivity at the same planning horizon as we do for innovation. Generally do innovation planning on a three to five year master plan and it was only logical to say why don’t we plan our productivity efforts on that same cycle to ensure we have sufficiency over that three to five year period and we can better synchronize productivity savings with the need for investment to innovation.
The last element the team decided was to build environmental sustainability into the company’s strategy. The way we deliver sustainability is easily described as three pillars: reducing our own footprint, gaining technologies that we have in the marketplace when we can’t scale them ourselves and monetizing them, like polypropylene recycling for example and the last one which is most important is to reduce the consumer’s footprint because that’s really where 80% of the footprint is of these products.
It’s in the water usage and in the heating of the water in the laundry cycle for example. And once we reframe the idea that way, it became a value creating and market growth strategy. If we enable consumers to bridge that gap between environmental sustainability and product efficacy, they don’t feel bad about using more. They don’t feel bad about doing the job more often. That grows the market and it grows value in the market because they’re generally willing to pay up for that proposition.
So, if you look at Ariel, four-chamber Liquitex in Europe, which is high performance and cold wash, which is the claim, we were able to reduce the wash temperature, deliver a packaging that is recyclable and sustainable and the business grew more than 20%. So, that’s the idea. So, long winded answer. But at the end of the day, it’s about executing the strategy enhancing maybe but not fundamentally tweaking.
Bonnie Herzog
No, that’s great. And then, as you describe that do you think you as an organization are better about sharing best practices? So, the example you just provided, how can you leverage some of the learnings from that, ultimately bringing that into other markets and vice versa?
Andre Schulten
Yes, for sure. I think the organization has learned the not invented here phenomena is largely gone. And we’ve all learned that cross-fertilization across these sectors is critically important and can accelerate. And we, John does a very good job of incenting that and celebrating these examples across the organization, which is a (big thing) (ph).
Bonnie Herzog
And then, you touched on this a bit earlier, but your company certainly was a big beneficiary of the superior supply chains that you have during, especially during COVID. It’s certainly many of your peers struggled to keep their products on the shelf. Now, as you think about today, competition really hasn’t stayed still and supply chains really have recovered and competition is intensified. So, could you talk to us a little bit about the steps you’re taking to sustain the superiority going forward?
Andre Schulten
Yes, I think the most important recognition of our supply chain is what our retail partners are saying. They’ve voted us number one supply chain in the industry on a global basis now for nine years in a row. That’s no need to stand still. It’s actually motivation for the team to go further. And they are driving every element of the supply chain, very simple things. First of all, we’ve learned, I mean, it took us a while to catch up to the level of demand we were able to create over the last five years. And what we’ve learned is that we need a higher capacity to demand ratio.
Number one, there’s more volatility in the demand pattern than there ever was. Number two, when we get all five factors of a proposition right, we are almost always surprised by the size of the upside. So, the first thing we did, and we are doing right now, is continue to invest in capacity so we have that flexibility to deal with the volatility and to deal with the upside that our propositions are generating.
The second element was to further build on the resiliency that we had started to benefit from in the supply chain crisis. What that means for us is have formulation flexibility. We have great digital capabilities to reformulate products, meaning reformulate ingredients, model that digitally, and then deploy it digitally to the production facilities, which allows us to reformulate in a matter of weeks instead of doing it for over six months or 12 months, which it took us before we had that capability. That combined with a supply chain where we have very intentionally moved from global of suppliers to more regional suppliers and local suppliers allows us to source differently if there’s an availability issue for a material or if there’s a cost arbitrage to be had. So, that capability we’re still building and expanding.
Digital and automation is a big topic in what we call supply chain 3.0. It’s the enabler of resilience, but it’s also the enabler of productivity and quality improvements. A simple example, typically in a diaper production line, we would sample batches of product. Pick a diaper; if there’s a defect, you have to scrap the batch. Now we have sensors and cameras on every line that basically checks every diaper that moves through that line. It avoids the batch issue, it avoids the scrapping, it improves quality, and it reduces manual labor as we don’t have to do that offline anymore.
Last element, I think our colleagues in the manufacturing sites and the distribution centers are our biggest asset. The work that they have done and are doing every day is critically important. Making sure we provide the right valuation to them to ensure we can attract the right talent and retain the right talent is critically important. But you’ll hear more about it. We’ll talk about supply chain 3.0 in more detail at our Investor Day in November, and I’m quite excited about it.
Bonnie Herzog
Thank you for that. Switching gears a little bit, I wanted to touch on the consumer, right? And as we sit here today, I’d love to hear your perspective on the consumer, especially the low-income consumer, as we’re really seeing some softening in some of the macro data. So, have you seen any shifts in consumer behavior as a result of these dynamics?
Andre Schulten
We have not. And we continue to see the same stability of our consumer that we’ve really observed over the last two, three years. I think it partially comes back to Bonnie, the categories we’re in. Consumers don’t stop doing laundry, they don’t stop buying diapers, they don’t stop buying Fem Care products. So, non-discretionary is a huge asset for us.
Number two, I think again driving irresistible superiority, so they understand — consumers understand the value that we are offering. And, we have built a portfolio of brands that cover both premium ends of the market and the value end of the market. We’ve built exercise portfolio that covers price points from $5 to $50. So, there is choice for the consumer to find their value proposition within our portfolio. And what that means for us if you aggregate it all up in North America or in the U.S., in our categories private label share is stable. I think that (technical difficulty) no movement in absolute private label share. And we continue to grow volume share, which means we have more consumers trading in our portfolio than trading out obviously. And once they come into the portfolio, we continue to see trade up in (technical difficulty) value proposition.
The same is true in Europe. Only difference being in Europe private label is growing as well. But, there is more of a bifurcation of the (technical difficulty). But even within that, we are able to grow share. And we are able to drive market growth in (technical difficulty). At the macro level, we don’t see trade down. Is there is some trade down when we don’t get things right? Yes. So, on a couple of brands, we don’t have the value equation right if it’s specifically value tier brands when you think about (indiscernible) and diapers. And we know how to fix it. So, the team is then very quickly thinking through what’s the innovation I need, what’s the product where I need to fix that value equation. But there is no broad trend in our consumer base that is shifting down.
Bonnie Herzog
Thank you. As an organization, you are faster. As I think back few years ago and certainly the different price tiers just more laser-focused ability to (technical difficulty) nimble in the market as the example you just you just described?
Andre Schulten
Yes, I agree. And I think the nimbleness is driven by having the accountability and the decision rights aligned at the right level. So, if you run the North America baby care business, you own innovation, you own the go-to—market execution all the way to the customer. So, you are enabled and powered and encouraged to make those decisions way more quickly than what you have to involve a global organization all the way back down. I think that’s helping us. I think the culture has also shifted. And, David was a huge advocate of transparency and straight talk. That has continued. We embrace the fact that if something is not working, it’s not working. And I think embracing — one of our leaders called it embracing the red. So, look for the red because then you can fix it.
Bonnie Herzog
And then, thinking about the price tiers and how you’ve successfully navigated that and limited trade down. Also, thinking about it in the context of promotional levels which have remained below pre-COVID levels and curious to hear based on decisions with retailers, do you see structural factors that support these subdued levels? And then — or if not, do you think promotional levels are going to kind of pre-backup maybe towards the back-half of this year? And in the context of that, how do you manage that while protecting margins going forward?
Andre Schulten
The promotional levels remained remarkably stable below pre-COVID levels in the markets where we have the best visibility which is the U.S. In Europe, we saw frequency come up to pre-COVID levels, but not depth of promotion, and so, all of those indicators are healthy. And I think they are a result of everyone (technical difficulty) margins at this point in time as we come out of the pricing cycles.
You see the commodity using is reversing, so you see some commodities coming back up. And so the cost pressure I think is increasing again. And generally, I think the more — you see many of our competitors adopting part of our philosophy of being market constructive and actually driving growth instead of taking share. I think that’s a great development for the marketplace for retailers, for the consumer. It means better products, better opportunities. We see pockets of that not holding true. So, there are some heaving promotions going on. Some categories – look, it always happens. I think our response is we would be competitive. But, we will ultimately win via delivering superior products. So, consumer (technical difficulty) —
Bonnie Herzog
Speaking of driving growth, something that we’ve been hearing about with investors is when you look at your (indiscernible) growth in last couple of quarters, it’s been good. But maybe a little bit below expectations. And then, in your last quarterly call, you did maintain your full-year organic growth guidance of 4% to 5%, but you no longer are targeting that top end of the range. So, with half the quarter-ish behind us already, just trying to get your sense of how comfortable you feel with that guidance and, ultimately, the growth?
Andre Schulten
What I’d tell you is, in the beginning of this conversation, I mentioned there’s more volatility than ever. That still holds true. But we feel very confident in the guidance that we’ve given. It’s a range for a reason, but 4% to 5% is absolutely where we think we’re going to land. And if you look at the underlying strength of the business, a, fiscal year to date, delivery exactly is 4.5%. So, if you just extract that out, I think we’re going to be able to deliver that. Most importantly, what I look at is consumption, not necessarily shipments. And we had few consumption to inventory effects here over the past couple of quarters, and I think those will even out. So, and when I look at just what the consumer behavior tells us, it’s right in that 5% range. So, I am confident.
Bonnie Herzog
So, on that point, the guidance also implies an acceleration in Q4, so this is more along the lines of the shipments and timing perspective for the full-year?
Andre Schulten
It implies an acceleration in shipments, not an acceleration in consumption. Consumption has actually been steady around —
Bonnie Herzog
The 5%?
Andre Schulten
The 5%. We saw some volatility due to shipment patterns. We don’t expect that to (technical difficulty) so that basically lines up consumption with shipments.
Bonnie Herzog
And really this algo is a medium and long-term, and I know you’re not giving guidance for next fiscal year. But it’s realistic to assume –?
Andre Schulten
It is. We assume the market will return to 3% to 4% underlying growth. (Technical difficulty) COVID, if you take out all the volatility during the past few years, 3% to 4% is what we expect. About half of that would be volume growth; the other half would be price mix. And then, our objective is to grow ahead of that by driving a disproportionate part of that market growth, which would land us in the (technical difficulty) —
Bonnie Herzog
And so, you just mentioned a better balance between volume and price mix moving forward, and that’s still the expectation. But as we think about whether it is a little bit more inflation with the commodity baskets rising, do you foresee maybe price mix seeing a little bit more of the equation, also as you look out into next fiscal year?
Andre Schulten
I think — I mean price mix has been a contributor to growth for P&G over the last 18-19 years almost every quarter. I don’t think that’s going to change. It’s built into the business model of — growing markets means bringing new users in, using more but also increasing the dollars per use, we need to have two of the three levels working to actually grow markets. So, dollar per use is always a component. And I don’t expect that to change. I think we will continue to drive productivity very hard, as I mentioned in the beginning. That will be the first line of defense. And we will price for commodity inflation where appropriate.
I think the organization’s confidence (technical difficulty) able to do that has gone up exponentially over the past two years (technical difficulty) of the combination of pricing with innovation, and therefore providing better value to the consumer — better perceived value to the consumer even as we needed to price. And that has resulted in market growth, share growth. So, I think we’re confident we can handle what’s coming.
Bonnie Herzog
So, the right to price is innovation. Okay. And you mentioned productivity savings. Now, that’s been a key margin driver in the past. And I think it’s been more than $1 billion per year in savings historically. So, they’ve stepped up in the past couple of years. So, can you help us understand what are some of the areas where these savings are coming from, and how we should look at that going forward, and if that will continue to step up?
Andre Schulten
Yes, it’s really every part of the P&L and the balance sheet. The biggest driver of the savings bucket is in cost of goods sold, and that’s partially the Supply Chain 3.0 dimensions I was talking about. It’s driven by the ability to reformulate for best cost. It’s the ability to use a lot of the digital investments we’ve made, a lot of the automation investments we’ve made (technical difficulty) drive productivity in our manufacturing sits. It’s our ability to combine thinking on the full supply chain. So, one of the main interventions we’re making is to physically and digitally integrate our supplier supply chain, our own, and the (technical difficulty) supply chain. And if you look at an end-to-end chain, the losses to be eliminated increase exponentially. And that’s where we find the biggest value. We’re just scratching the surface here. But I do think that will become a significant contributor to our ability to sustain about $1.5 billion in annual cost of goods savings. We continue to roll out media capabilities around the world. We have first-party data. We have algorithmic solutions that allow us to build very effective cohorts, cross screen measurements for reach and effectiveness of reach and bringing all of that in-house allows us to optimize media spend.
So, we estimate about $500 million of savings annually from our own optimization efforts. And then, there’s always a company as big as this, there’s always other processes you find. I think the most important element is every unit, every Manager, every CEO understands that productivity is a core enabler to growth. So, it’s within the DNA. There’s no discussion we have on innovation, there’s no discussion we have on top line growth without an equal part of that discussion being focused on productivity.
Bonnie Herzog
And then, in the context of that, your gross margin delivery so far has been quite impressive. So, how should we think about reinvestments into A&P as well as R&D? And as I look at it as a percentage of sales that has dropped a little bit over the past few years, is that at appropriate levels, or do you think that needs to be elevated, especially as you drive further productivity savings, reinvesting in the business, how should we think about that cycle?
Andre Schulten
I really don’t — we don’t think about the percent of sales as the measure, and we don’t think about an appropriate level. What we tell the business units is your focus is irresistible superiority. And if you can drive better communication that drives sales, we are driving more investment in the business, go for it. But you have to live with the consequences. So, you have to be sure that the investment you’re driving drives ROI within a reasonable timeframe. You have to do the due diligence beforehand and you have to do the due diligence in post event analysis to ensure it delivered. As long as that’s the case, we don’t put any constraints on it. Once we see that correlation break, then we’ll have a different discussion, but so far that is not the case. Percent of sales coming down for me is a good thing. It’s not a sign of underinvestment, quite the opposite.
It’s a sign of the efficiencies I was talking about actually manifesting themselves in the channel, which is what Bonnie, on the R&D point specifically, what Andre just said applies there also specifically, right? A lot of the digital tools that we’ve implemented in all other facets of the business are happening in R&D also. We’re actually getting more innovation and ideas vetted much earlier digitally now that helps increase the speed, but lower the cost of that innovation. So, the efficacy is not going down because the percent of sales is going down. In fact, I think it’s getting better because we’re focusing on fewer, bigger innovations but vetting those ideas out much faster.
Bonnie Herzog
That’s helpful. That’s going to ultimately drive the top line. And then, as I think about going back maybe to gross margin, it’s been again a driver of your strong results of the year so far, so thinking about your guidance, which implies the step up of the top line growth in Q4 that we talked about and the favorable cost environment. Is there any reason why we shouldn’t expect gross margins to sustain at that 51% level we saw in Q3, or do you expect it to step back down? Thinking about what we’re seeing for the rest of the year.
Andre Schulten
I will refrain from giving any margin guidance, growth or operating, but look what we’ve said all along I think the tailwind on the gross margin is easing a little bit. We had very favorable commodity tailwinds in the front-half of the year and we had a little bit of foreign exchange rate headwinds in the front-half, but that’s reversing.
So, the net of those two, we now see commodities coming up. There will be a limited impact on this year, but it’s no longer a tailwind in quarter four. And we have foreign exchange moving against us. So, you put those two together offset by strong productivity and the fact that the pricing annualization has largely happened in Q3. So, the price mix contribution is going to ease in Q4. You can see mathematically there’s going to be some pressure on the gross margin in Q4. But I mean, we’re very pleased with where we end up structurally on the year from what we can see and I think that’s perfect for gaining momentum both on the top line and bottom line.
Bonnie Herzog
You just mentioned that on the COGS bucket, it’s no longer a tailwind. How are you covered in terms of your costs when you look out over the next fiscal year? Do you have visibility and do you hedge on some of your cost buckets?
Andre Schulten
We don’t hedge. We generally use spot prices to forecast for the following year. Our ability to offset commodity fluctuation in our total exposure basket is the way we deal with the first level of volatility. You look at our commodity basket, look at our currency basket, and you look at our interest rate basket. Those combined offset about 70% of the earnings impact at any given point in time and 95% confidence. So, that’s a pretty good first level of hedging that we don’t have to pay any money for, which we like. And then, the most important thing for us is to continue to push that productivity muscle. And I honestly believe not hedging is actually a big incentive for our businesses to deal with the issue ahead of them, which means you can’t offset it with productivity, take the pricing when the market needs to take the pricing, which is, I think, the approach.
Bonnie Herzog
That makes sense. I wanted to circle back on just growth and top line and drill down a little bit on China, which has been soft for the past several quarters. And several investors we’ve talked to about this have expressed some concerns in general about China’s long-term growth potential given the macro challenges in the region. So, could you maybe talk through how your strategy in the region has evolved and then ultimately what underpins your expectation for a return, I believe, to mid-single-digit growth in the market?
Andre Schulten
Yes, we’ve been in China for 30 years. And I would say the way that the strategy evolves is China today to us looks much more like a developed market. While if you look at the last five, 10 years, it was all about chasing the growth, being in the right retail channel, but the demand — the consumer demand was there. Now we have to work to create the demand. We have to work to create category growth, which we believe plays to our advantage, because that’s what the strategy is, that’s what our capabilities are. We have a dedicated R&D capability on the ground for China, our supply chain in China is for China, and we have a very strong commercial and go-to-market team in China. So, I think we’re well set up to drive that category growth, which will ultimately be the catalyst to return to mid-single-digit growth. The consumer at this point in time is not confident.
Bonnie Herzog
Yes.
Andre Schulten
Right. And you can tell, I mean, we see improving market conditions, but we’re not yet seeing optimism, which ultimately gives us some tailwind to drive category growth. We said all along this recovery will be volatile and bumpy. I think it’s proven to be. So, at the end what I’ll tell you, Bonnie, is we’re not counting on China to be a major contributor to growth over the next quarters. But we are confident at the same time that it will return to growth and the middle class rising, ultimately the economy recovering will be a catalyst for that happening and our role in that with our retail partners is to drive growth, which is the playbook we know.
Bonnie Herzog
And then, thinking about SK-II and that brand, especially in China, I believe the expectation is it should improve in Q4 versus sequentially in Q3. I know when you look at your skin and personal care organic sales growth, it was down low single digits and I think that was driven by lower sales of SK-II. So, maybe talk a little bit about that brand and some of the key markets and just really wanted to understand the drivers of the improvements that are expected behind that brand forward.
Andre Schulten
Yes, the first thing, the brand fundamentally is very strong. If you look at SK-II growth outside of China, it’s growing double digits. The brand fundamentals are healthy. But the brand in and of itself is very strong. It’s impacted in China due to a general negative sentiment towards Japanese brand with a focus — (technical difficulty).
Second thing, we’re not counting on the recovery of SK-II in Q4. I think we’re leveling out, but I think it will take a couple of quarters before the business comes back. What we’re doing to bring the business back, I think, is really just fundamental rebuilding of the brand’s equity and brand trust. Taking the (technical difficulty), there’s a huge group of consumers that are very loyal to the brand. Taking them and have them help authenticate the quality of the product, the safety of the product, the core benefit in anti-aging and heroing the core of the brand, which is the facial treatment essence, getting back on national TV, drive awareness, and so rebuilding really the brand fundamentals. We’re bringing super premium innovation on the brand, which I think speaks to the segment of the market that is probably most resilient. So, I think the team is doing everything right, but that takes time.
Bonnie Herzog
And just maybe time for one more question. Capital allocation, and in the context of that love to hear thoughts on potential M&A and how you think about that for driving further growth. And I know your free cash flow has been quite strong. You announced a dividend increase recently and certainly buying back your stock. So, what else in terms of capital allocation and how do we think about M&A in terms of a priority (technical difficulty) —
Andre Schulten
I think priority number one continues to be to fully fund the business. I was talking about capital investments and capacity. All of that can be done within the existing algorithm, so I don’t think it changes anything, but priority number one is fully fund the business, which is grounded in the insight that we have enough growth potential on the core business as we have today. Those categories are growing at a 3% to 4% clip. We can add a point or two on top of that, which is right where we want to be. And we have runway to do that for a number of years. We will continue to pay and raise the dividend. I don’t want to be the CFO who changes that.
Bonnie Herzog
Okay. Good idea.
Andre Schulten
And we will look at M&A more technically, Bonnie, quite frankly. We’ve had great success in bringing in brands that are grounded in daily use categories and they are built on product priority technology, even in beauty care. And when we bring those brands in, we can scale them, we can develop them and we’ve grown native from 100 million to around 800 million. That’s the type of acquisition we want to drive, nothing transformational.
Bonnie Herzog
All right. Thank you. We’ll end there on that note. I appreciate your time. Thanks for joining us today.
Andre Schulten
Thanks, Bonnie. Thank you.
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