By Amy Tsao With the rough-and-tumble market providing so few havens, shares in companies that make products people use every day -- cereal, soft drinks, toothbrushes -- have soared. Such companies are considered staid but reliable, their appeal stemming from their ability to deliver consistent returns regardless of economic conditions.
Gillette (G) looks like a good example. Lately, it has been trading more like a growth stock than a steady consumer-staples company. Investors bid up its shares by 5% after Gillette released its third-quarter earnings report on Oct. 19. Sales rose just 2%, to $2.36 billion, and the company posted net profits of $296 million, or $0.28 per share, down from $350 million, or $0.33 a share a year ago.
While the performance was less than stellar, the razor giant met expectations for the quarter. And analysts point to signs that Gillette is chipping away at some nagging problems.
"NOT CHEAP." "Across the board, the company has shown some improvement," says Banc of America Securities analyst William Steele of Gillette's most recent quarterly results. Steele points to a substantial increase in spending on marketing key products, an improved balance sheet, and successful inventory-reduction efforts. And some analysts are pleased with the emphasis CEO James Kilts -- who came on board in January -- has placed on premium razors and blades, and his efforts to boost the Duracell battery business.
But appearances can be deceiving. While Gillette's achivements provide some reason to cheer, its ability to execute a return to stronger profits during a recession looks risky. Among it problems: Consumers could be slow to adopt its expensive line of razors and blades in today's difficult economic times. Duracell will likely keep struggling amid strong competition. The currency picture isn't likely to improve any time soon for its international operations. And with a trailing price-to-earnings ratio of 52, Gillette's stock is one of the most expensive of its peer group.
"The stock is definitely not cheap when you look at it from a p-e perspective," observes Howard Choe, a consumer-staples analyst at Standard & Poor's (like BusinessWeek Online, a unit of The McGraw-Hill Companies). "If you look at it from a sales angle, I would say, yes, it is a defensive investment. But it's also a turnaround story at this point," he says, noting the company's stunted growth of the last several years.
UNSTOPPABLE. How far Gillette is in the turnaround process remains unclear. By comparison, Colgate-Palmolive (CL) shares, another defensive, consumer-products investment, are trading at a p-e of 31 even though that company has relatively few problems, and all of its divisions were solid contributors to its recent results.
David Kerans of Argus Research agrees that Gillette is too expensive. "The stock seems to be priced more toward its potential than its current performance," he observes. He rates it a hold and wouldn't recommend buying until it's around $25 a share, down from its current price of just above $31.
Gillette's bread-and-butter business in blades and razors is at the heart of its potential. Its Mach 3 and recently introduced Venus brands top the men's and women's disposable-razor categories, respectively. "[Gillette's] biggest advantage is its unassailable dominance of the shaving markets. No one can stop them," Kerans says. In the third quarter, sales of razors and replacement blades rose 7%, though profits declined 4% as Gillette continued to spend on heavily on advertising for Venus.
RAISING PRICES? When it comes to its pricey razors and blades, competition doesn't weigh on Gillette nearly as heavily as the challenge of recruiting new users during bad economic times. The company will be trying to convince the world that its shaving products, at about $7.50 for the razor and $7.50 for a packet of 4 replacement blades, are worth buying even though much cheaper alternatives exist.
"In times like these, people don't trade up," Kerans says. "Demand is elastic, but people have a choice of price points." Gillette execs weren't available to comment for this article, but the company has told Wall Street it has so much confidence in its high-end shaving products that it plans to raise Mach 3 and Venus prices by 5% in 2002.
Batteries are a different story. Duracell is still the top-selling brand, but price wars have made it tough to hold onto market share, says Eric Jemetz, an analyst with New Amsterdam Partners. "They've had issues in terms of the competitiveness of the Duracell brand -- overestimating the brand's strength," he says. Markdowns to compete with rivals Energizer and Rayovac boosted Duracell sales 1% in the third quarter, up from an 11% decline a year ago, but the heavy price-slashing and large marketing costs created a 55% drop-off in operating profits for the battery division.
"AN ALBATROSS." The steep decline in battery profits isn't likely to stop for some time as Gillette plans to continue the price war while spending more on marketing to boost share. Also, batteries, unlike razors, are gradually becoming commoditized. "The margins are still depressed, and they'll never get back to where they used to be," says Bernstein Research analyst Jim Gingrich. He remains optimistic, however, that Duracell margins will improve down the road.
Argus Research's Kerans calls Duracell "an albatross, not a lifesaver." He notes that a projected slowdown in spending on battery-powered electronics will add to the pressures. Plus, Wal-Mart Stores (WMT) is turning into a real competitor in the battery market, with sales of its EvrActiv line having jumped 16% so far in 2001.
The strong U.S. dollar is also hurting Gillette. Kerans notes the company draws almost one-third of its revenues from Europe, where the euro has lost 1.4% of its value, year-over-year. Latin American and Asian currencies are also troublesome. According to the company, unfavorable exchange rates meant a net drop in sales of 3% compared to the third quarter last year.
Still, Gillette's main business -- razors and blades -- remains a powerhouse that should keep growth sharp. "Longer term, the thing that's intriguing is the opportunity that new management has to create value in a set of assets that are better than any other stock I'm covering," Gingrich says. In the near term, however, the slumping economy will likely keep Gillette in check. Tsao covers financial markets for BusinessWeek Online in New York