Time to Break Up P&G? This Man Thinks So

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“[Online shopping] is the Wild West, and that’s throwing consumer-products companies for a loop.“—Ali Dibadj Photo: Peter Murphy for Barron’s
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You might have caught Ali Dibadj, 41, over the past year on CNBC or in the financial pages, calling for a breakup of Procter & Gamble . Dibadj, the highly ranked household products and beverages analyst at Sanford C. Bernstein, is a thorn in Procter’s side, not least because he once advised the company as a consultant. Dibadj trained as an engineer and as a lawyer at Harvard, then worked as a management consultant, eventually becoming a leader of McKinsey & Co.’s consumer goods and retail practices. Then he decamped for Wall Street, where he has spent the past several years at Bernstein. We caught up with him recently to talk about Procter, Coca-Cola , and other widely held consumer-products stocks.

Barron’s : Ali, for a long time you advised companies as a management consultant. Why did you move to Wall Street?

Dibadj: Consulting is a great grounding in terms of understanding businesses. As a consultant, I might do a cost-optimization project or an integration project for a particular company. But on Wall Street, you can see how integrations have done and pick who is going to win and who is going to lose. When you are consulting, the CEO is your client. In this role, the shareholders are your client. It gives me a BS-meter. I can question management operationally much differently. That’s the Bernstein model anyway—bringing in people from industry who can ask tough questions, check on management teams a bit aggressively, raise the level of conversation. Because of my background, I push companies to do things that are uncomfortable, but benefit shareholders.

Will your industries beat or trail the S&P 500 over the next year?

We watch the market all the time. Right now, it’s very much of a risk-on environment. Two months ago, it was all the rage to own consumer staples. Now people are more cautious. If the macro environment stays where it is right now, it will be a source of funds. That doesn’t mean there aren’t great absolute opportunities, like Coca-Cola [ticker: KO].

The incumbents in the consumer world developed their brands by advertising and locking in the consumer. Soap operas were invented by Procter & Gamble [PG]. Now there are many other entry points. A consumer may like what a product stands for, or see a good review, or just try a brand because it looks interesting. I can go on Amazon, search for a product, and just buy it. I am not constrained to the shelf space Wal-Mart is showing me. It is the Wild West, and that’s throwing consumer-products companies for a loop. There used to be more brand loyalty in consumer packaged goods, as well as regulatory requirements.

How do you quantify the risks?

Mainly by trying to find other industries destroyed by the shift online—say books or consumer electronics—and then tempering the outlook for consumer packaged goods, which have lower prices and brand loyalty. Companies like Estée Lauder [EL], Procter, Kimberly-Clark [KMB], Clorox [CLX] have put their best people online. Colgate-Palmolive [CL] is in denial, Avon Products [AVP] is trying to figure it out, Church & Dwight [CHD] still thinks it’s a later-adoption type channel. There are stark differences between the winners and losers. It is very difficult to disrupt the winners in Amazon, say, because products are purchased by their ranking on search. And those rankings are related to how often a product is purchased. So the moat is very, very difficult to break down. Health and wellness are big issues. In my beverage names, people don’t want artificial flavors. That’s becoming a big challenge. Sugar costs a lot more than aspartame. Some companies argue the only way to grow a business is to be more promotional, much more in-store focused. I believe training the consumer to be price-focused is a bad thing.

What do your consumer surveys say about various markets?

Our macro data suggest that the U.S. consumer is steady to getting better. As for emerging markets, not all are the same. In Brazil, the consumer is under a lot of pressure; Mexico seems fine, Venezuela has lots of problems. Russia is pressured, but less badly than Brazil. China has slowed, but doesn’t look like it’s getting worse. India is still the star of the show, but is still a very small portion of sales. We think most key emerging markets will stabilize over the next 12 to 24 months, with Brazil a question mark. Latin America is still a very big risk zone. Colgate to us is a question mark, although they have very, very good share and that may be enough of a moat for them to reduce pricing. Avon’s business depends on Brazil, so they could trade down to their lower-end products or experience the pain of that customer. And Procter has very much lost its mojo in China.

In fact, you’ve said P&G managers should break up the company. That must win you a lot of friends there.

Think of Procter’s brands, distribution network, employees, and you come away being very positive. Then look at what they’ve delivered, and you scratch your head. There are two main reasons. One, the culture lacks accountability. Two, it is focused on tenure. When something goes wrong, there is no real reason to fix it quickly. The company is attempting to change. My issue is that I have no example, either in this career or my previous one, of companies that changed their cultures without significant outside influence on the board or management teams. Also, they are too darn big. It’s such a complex organization. You can’t actually change your small business unit as part of this big conglomerate and have an impact. They can change how people get paid, cut head count. But they are a big conglomerate. Procter has had lots of successes, but not over the past decade. That’s a long time, as an investor, to wait.

What grade would you give CEO David Taylor for the six months he’s been in charge?

It’s too early. He’s saying the right things. He is not an outsider. He can’t just throw [former CEO and current executive chairman] A.G. Lafley under the bus. I would like to see more progress. They keep saying they will bring accountability, that incentive compensation will be based on what employees can more tangibly control. Ask them when they’ll be able to do this, and it’s always in six months, in six months. For two years, we’ve heard about their issues in China, such as not having the right pricing tier for diapers. Nothing has changed. If there is no sign of a share pickup or of closing price gaps in 12 months, you’ll have a lot of frustrated investors. Also, the CEOs at P&G have decided not to come to their quarterly earnings calls regularly. I don’t find that, frankly, very respectful to shareholders.

Yet you are bullish on Procter & Gamble. Why?

We think the company will stop losing share. It trades at a discount to its peers. If it starts to grow like the category, it should have a much higher multiple than it does today. There is not a lot of downside with the 3.3% dividend yield, and we think the price/earnings multiple can get to the low-to-mid 20s from around 21 today. Our price target is $87, versus $82 today, but with more cost-cutting and top-line growth, we could get to $117.

What’s your thesis for Coke and Pepsi?

Coke is the best stock in staples right now. The carbonated beverages industry is now working more in concert. They’ve cut back on promotion, deflationary pricing, and beating each other’s brains out, which was not helpful in an industry that is not growing volumes. The worst place to invest is with a company that thinks its growth trajectory will be much higher than what it actually is. If you believe your growth rate will be 5%, you build your cost structure for that growth. If the top line doesn’t come in, you have some serious problems on margin. The carbonated soft drinks industry has realized that in developed markets it won’t grow as fast as it did before. So they move the price mix up, cut costs. That’s the inflection point you see now in Coke and you saw in PepsiCo [PEP] a few years ago.

Coke faces a lot of skepticism that it can reach its 2016 target of 4% to 5% organic growth.

You can’t just do 4% to 5% in volumes—I think it will be 2% volume short-term and maybe 3% pricing on a global basis. Pricing was never a lever they pulled in North America or Western Europe. Now it’s the new algorithm for them. Coke now has smaller bottles and cans that they are selling in coolers. This is a shift. The consumer doesn’t want this as hydration, they want this as a treat—cold on a hot day or as a little pick-me-up. They’re divesting their bottlers, trying to become asset-light. Coke’s operating margins will go up by 10 percentage points over the next two to three years, as it divests its bottlers, which are much lower-margin businesses than selling syrup. So I think a 23, 24, high 20s multiple on forward earnings is not crazy for this company. My target for the stock is $50.

As for Pepsi, it wasn’t optimally run. They had a food headquarters, beverage headquarters, corporate headquarters. Either integrate more to get rid of those costs, or split up—not too different from what some activists have suggested. Pepsi chose to integrate more and, to its credit, it’s much leaner. They have a billion dollars of cost savings a year. Is Pepsi better served by breaking up? Maybe not right now, but unless these things are getting very integrated, and the top line is lifting, breaking up is still an option. I wonder whether their trajectory includes an acquisition, such as beefing up their Frito-Lay snacks business. On a P/E basis, relative to peers, we don’t think low- to mid-20s is odd. My target is $115.

Estée Lauder is another favorite.

It’s probably the best company that we cover. Bleach is pretty much exhausted. People already use toilet paper. But things that are less necessary, like cosmetics or fragrances, have a longer trajectory of adoption. Estée Lauder is also in prestige lines. That’s a double benefit. Their growth rate is 6% to 7%, and it is probably accelerating. On top of that, they have a very attractive margin structure, and opportunity to cut costs. The multiple could be in the high 20s, versus 25 today. The one short-term risk is they are very dependent on China. I think the stock is worth $102.

Why do you dislike Colgate and Clorox?

Both have done an extraordinarily good job, but their top-line trajectories are going to slow. Clorox is very North America–focused, which is great defensively, but not the best positioning from a growth perspective over the long term. They’ve done everything they can in terms of gaining share and cutting costs. When you get to the point where you’re leasing back your headquarters, you’ve done everything right. As for Colgate, it has 70%-plus market share in Latin America. The use of toothpaste is extraordinarily high in Latin America, so there isn’t a lot more room to grow. We have neutral ratings on both, but we’re cautious on the multiple, relative to peers. Our target for Clorox is $119, versus $133 today, and for Colgate $67, versus $72 today.

Thanks, Ali.

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