The Tide Is Turning at P&G

But robust profits, based on cost-cutting, may not last

For nearly a year and a half, Procter & Gamble Co. (PG ) investors have looked for signs that a turnaround is gaining speed. They got the strongest signal yet on the morning of Mar. 19, when the consumer-product giant--maker of Pampers, Crest, and a host of other familiar household goods--reported that it would soundly beat Wall Street estimates of $0.81 per share for the quarter ended Mar. 31, with profits rising 10% or more year-on-year. That meant the company would meet its own goals sooner than planned. At an investors' conference, P&G execs seemed confident that the dark days of two years ago, when it routinely missed making its numbers under former CEO Durk I. Jager, were over.

Investors are certainly buying into that optimistic view. In the past year, P&G stock has risen 43%, to about $90 a share. Some of that gain has come because investors have fled the tech sector and sought safe haven in Old Economy stalwarts. But the stock climb, say analysts, also reflects some smart moves by CEO A.G. Lafley, who was unavailable for comment.

Since he took over the helm in June, 2000, Lafley has cleaned house at P&G. He has gotten rid of slow-growth products such as Crisco shortening and Comet cleanser. He has brought a new focus and resources to core brands such as Tide. And he has sought out faster-growing, more profitable areas such as beauty and hair care. Case in point: Last November, P&G shelled out $4.95 billion for Clairol Inc.

Moreover, Lafley has proved an adept cost-cutter. Reorganizing P&G, he will wring out $700 million in costs this fiscal year. Some of that has flowed directly to the bottom line, while some has been used to back promotions and price cuts for P&G mainstays such as Tide.

And unlike the Jager regime, which was eager to show big gains when P&G was competing for investor attention with the glittery tech sector, the more subdued economy has allowed P&G to set achievable goals. That has made it less likely to disappoint investors. Lafley has scaled back P&G's long-term performance goals to 4% to 6% sales growth, from 6% to 8%, and to "double-digit" earnings growth instead of Jager's specific 13% to 15%.

For all that, nagging worries still exist that P&G cannot meet even those reduced targets for very long. "The company is not out of the woods yet," says Patrick Schumann, an analyst at Edward Jones. For one, P&G is creating most of the growth in its existing brands through discounting. That explains why sales in the most recent quarter rose by just 2%, while unit volume climbed by 4%. Lafley's strategy is to use promotions to win over customers, who will then stay with a brand as pricier versions come out. But it may be a risky plan. "Consumers are only loyal to the brand that is on sale," warns Albert E. Lees III, president of Lees Supermarket, an upscale grocer in Westport, Mass.

Moreover, P&G's promotional strategy depends on savings from its restructuring and division sales. But that $700 million windfall won't last forever. P&G already projects those savings will fall by 40% next year.

To keep its momentum, P&G badly needs some new blockbuster products. Recent product launches, such as the Swiffer electrostatic dust mop and Fit Fruit & Vegetable Wash, have had limited success. Crest Whitestrips, a tooth whitener, has brought in $100 million in its first six months on the market, say analysts. But nothing has substantially boosted the company's overall sales. And when P&G establishes a new market, nimbler competitors quickly move in: The latest iteration of Swiffer, for instance, was quickly outflanked by Clorox Co.'s new ReadyMop cleaner.

For now, investors are happy. But without strong new products, will they be content in a few years, when cost-cutting savings wind down? Says Wendy Nicholson, a Salomon Smith Barney analyst, "I don't think many investors are thinking that far out." Maybe they should be. If P&G can't come up with hot sellers, shareholders could find themselves back in the dark days.

By Robert Berner in Chicago and Gerry Khermouch in New York

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