Sector Scope by James A. Anderson November 8, 1999

Household Products: A Sector with a Split Personality
Analysts say what's separating the leaders (P&G, Kimberly) from the laggards (Gillette, Avon) is focus

It’s the mystery of the medicine cabinet, the case of the indelible stain. Some of the best-known makers of household brands and personal-care favorites -- everything from laundry detergent to shaving cream -- have had a bum year on the stock market at a time when you might think things couldn’t be better.

Shoppers, after all, are employed and happy. Consumer confidence is up, and sales of big-ticket items such as automobiles and homes are strong. Yet Gillette (G), long a favorite on Wall Street, has had trouble meeting earnings expectations quarter after quarter. Its shares have been shorn of nearly 25% of their value since January, and indications are that it won’t be turning the corner soon, with sales on the decline and the company busy tending to its diverse brands. Shares of Clorox (CLX), another company with troubles, are down 20% this year. And at Avon (AVP), things have gotten so bad that Chief Executive Charles R. Perrin cleaned out his desk last week, leaving shareholders with a decline of 33% in the wake of his departure.

True enough, a Standard & Poor’s index of eight nondurable household product companies is up 11.2% for the year. Look closer, though, and you’ll see that the market capitalization-weighted index has been buoyed by Procter & Gamble. Cincinnati’s brand-name kingpin makes up more than 60% of the index and has returned investors 17.5% so far this year. Five members of the index, including Dial Corp. (DL), Clorox, and Fort James (FJ), are down 10% or more.

At the same time, an S&P index of seven personal-care stocks -- names such as Avon, Gillette, and Carter Wallace -- hasn’t fared even that well. As of Nov. 5, it was down 26% for the year.

NEVER STOP BRANDING. Analysts say the disparity between the leaders and the laggards reflects one primary thing: Focus. The companies that are succeeding have stuck to nurturing their brands. In other instances, "you’ve seen companies step away from the basics and get a little caught up in impressing Wall Street with numbers," says William Steele, an analyst for Banc of America. The laggards, he says, have often gone for short-term earnings rather than spend on the promotion and advertising they need to thrive.

"There’s a simple recipe for success in this group," says Steele. "You need cash flow to leverage strong brand names. That starts by first improving internal operating efficiency in order to generate cash flow to reinvest behind the brand with ads, promotion, and new product development." The more of that you do, the higher your product volumes and the greater your earnings, which means that you have more money to put to work in wooing more customers. Steele says the companies that are currently outperforming their peers, such as P&G, are focused on these basics.

Then there are cases like Gillette. Its razors still dominate their market, and its new three-blade wonder -- the Mach3 -- is a world-beater. Still, poor showings by its household-products division, Braun, and its line of Paper Mate pens, have hurt earnings. Late in October, the company indicated that its fourth-quarter results would fall well below expectations -- in the 32 cents to 34 cents per share range, vs. the Street’s expectations of 42 cents. The news immediately prompted calls for management to hawk units that are a drag on profits.

CONCENTRATED POWER. Another floundering stock is Avon, the beauty-products maker. Avon has embarked on a cost-cutting spree in an effort to produce $400 million in savings by next year, although it might be a bit late to help the stock this year. Avon recently told analysts to expect fourth-quarter earnings of 56 cents a share, instead of the 63 cents Wall Street had projected. Analysts say North American operations, which account for 39% of Avon’s sales, are the culprit.

Doing a good job on marketing is especially important in an era of superstores and discount chains: A wave of consolidation is concentrating more power in the hands of fewer retailers. Meanwhile, retailing giants such as Wal-Mart (WMT) have made plain their desire to attack the best-known brands in everything from baby oil to sunscreen with their own private-label goods. That’s particularly worrisome given that Wal-Mart represents 10% to 15% of the sales of a good many household and personal-care companies.

Brand support in the U.S. can also counter the lackluster results many consumer brands have suffered overseas. Markets across the Atlantic and Pacific have been a bust of late. A strong dollar has muted profits in Europe. Brazil’s devalued real has helped drag down profits in Latin America, spelling trouble for companies such as Gillette, which gets 67% of its sales from outside of North America. Demand from Asia has also been weak, although an economic turnaround has started there.

TOTAL-LY TERRIFIC. Despite the miscues of some members of the group, a handful of companies in the household and personal-care group have done pretty well in 1999. P&G and Colgate-Palmolive have outrun the S&P 500’s 11% gain this year, with total returns of 18% and 26%, respectively, and could well maintain their momentum. Kimberly Clark, a turnaround bet, is up 22%, thanks to its strong presence in diapers and paper products.

Colgate is perhaps the steadiest performer in the group, one that has a reputation for routinely coming close to its earnings projections. "They’re the one company in this space that hasn’t disappointed, even though they’ve had every opportunity to do so," says Michael T. Manns, a portfolio manager with American Express Asset Management Group. "The company has held on, even with its exposure to Latin America. They just don’t goof up."

Colgate has done well partly because of successful new products, including Total toothpaste. Total has been so popular that it has helped Colgate unseat P&G’s Crest as the No. 1 seller in the U.S. Salomon Bros. expect the anticipated launch of a new variety of Total in 2000 to help the company maintain its momentum. Currently, 11 of 14 analysts who follow Colgate rate it a "strong buy" or "buy" according to Zacks Investment Research, which reports that the Street looks for the company to deliver 13% average annual earnings growth over the next five years.

PAPER PLAY. Two weeks ago, Kimberly Clark would have been a good contrarian pick. That was before it made a 12% runup to close on Nov. 5 at $65.50. For the past few years, Kimberly Clark's biggest challenge has been to complete the integration of Scott Paper into the company -- a nightmare that dragged down earnings. That acquisition is now paying dividends, however. "They’re a very misunderstood story," says Banc of America’s Steele. "They’ve disappointed in the past, but they’ve worked to divest noncore assets and have gained market share by bringing new brands to market."

The company still has upside, says Steele. Huggies, the diaper line, has been a big hit for Kimberly Clark, which holds a market-leading 44% of the infant diaper market. New lines such as Huggies Ultratrim and Huggies Pullups have thwarted the catchup efforts of P&G’s Pampers, which is No. 2 in diapers. Currently, Wall Street looks for Kimberly's earnings to grow 12% annually over the next five years, and all 13 analysts who cover the stock rate it a "strong buy" or "buy."

As for mutual funds that specialize in producers of nondurable items, you might want to check into the Fidelity Contrafund (FCNTX). Contrafund, which has an average annual total return of 24% over the past three years, had positions in both Kimberly Clark and Colgate as recently as June 30, according to Morningstar. The Fidelity Select Consumer Industries Fund (FSCPX), a more narrowly focused offering, has managed a 21% average over the same time period. Contrafund is up 11.33% so far in 1999, while the Select Consumer Industries fund is doing slightly better, up 11.53%.

Anderson, whose Sector Scope column appears twice a month on BW Online, teaches journalism at the City University of New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

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