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Stock Strategist

Keep These Firms on Your Shopping List

Household-product firms have recovered nicely from past troubles.

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Research has demonstrated that shoppers who use a list while grocery shopping are more likely to have lower grocery bills over time, because having a list reduces the inclination to make spontaneous purchases of less-needed items. Given our preference for buying stocks on sale, however, we're unlikely right now to make any spontaneous purchases of household and personal care (HHPC) stocks. Except for one terrific exception in  Procter & Gamble (PG) (see last month's article, "Why P&G Looks Like a Buy"), we believe most of the consumer-products stocks we cover--including  Alberto-Culver (ACV),  Colgate (CL),  Clorox (CLX),  Kimberly-Clark (KMB),  Energizer (ENR),  Playtex (PYX), and  Newell Rubbermaid (NWL)--are fairly valued. Some of them have been on sale in the past, however, namely Colgate and Kimberly-Clark, and there are some compelling reasons to keep them on your shopping list should they go on sale again. After several challenging years, these companies are fundamentally healthier now, and as providers of staples consumers use every day, they'll be less susceptible to economic fluctuations.

Trouble in the Cupboard
Over the past several years, there's been a fair amount of turmoil for the manufacturers of ho-hum products like detergent, shampoo, batteries, and toothpaste. The biggest impact has been from commodity cost increases, with raw material prices for oil, natural gas, resin, pulp, and zinc rising dramatically and torpedoing profitability. HHPC firms have struggled to find cost savings and push through price increases to keep gross margins from eroding. It's no surprise then that over the past several years these firms have had to take a good hard look at their manufacturing cost structures and restructure their operations in order to find savings to offset these input costs. Whether outsourcing manufacturing to third-party vendors with lower overhead costs, or closing plants in mature markets and building them in lower-cost developing markets that are closer to future growth opportunities, none of the HHPC firms have been immune to some sort of cost-cutting or restructuring, as the examples below illustrate:

  • Colgate is on track with four-year $750 million-$900 million (pretax) restructuring plan, which should generate $325 million-$400 million in annual savings; it's closing one third of its factories
  • Clorox restructured the Glad supply chain in fiscal 2005; it's currently restructuring information technology services; it's streamlining home-care supply chain over three years with annual savings of $17 million-$22 million expected; and an additional $45 million-$55 million in further supply chain charges is possible
  • Energizer restructured European packaging and distribution in fiscal 2006 for $24 million; integration of sales and administrative functions in Europe should cost $25 million-$35 million and yield $19 million-$24 million in annual cost savings
  • Kimberly-Clark is streamlining manufacturing and administrative operations, primarily in North America and Europe; $950 million to $1 billion (pretax) in charges with savings of $350 million annually by 2009; closure or sale of 17% of manufacturing facilities
  • Newell Rubbermaid is restructuring distribution, shared services, and European operations for $375 million-$400 million to be completed by 2008, with annual savings of $150 million or more expected by 2009
  • Playtex extended its business realignment plan in 2005 that was started two years earlier; costs of $16 million and savings of $23 million in 2006

In conjunction with lowering costs via improved manufacturing capabilities, HHPC firms have raised the bar for brand reinvestment. Over the past several years, the firms have sold underperforming brands to focus on fewer, winning brands with top market shares. Playtex divested Mr. Bubble, Baby Magic, and Woolite; Newell Rubbermaid sold Little Tikes; P&G sold its European paper towel and tissue business; and Colgate recently sold its Canadian and Latin American bleach business to Clorox. These companies are culling their product portfolios in order to focus their resources on brands that can secure the number-one or number-two positions on retail shelves. The rise of  Wal-Mart (WMT) and  Target (TGT) have made having top brands an imperative for HHPC survival, because the large retailers often only make room on their shelves for two branded offerings plus one private-label competitor, depending on the category. Between rising costs putting the squeeze to margins, and retailers demanding faster sell-through of products, there's been little room at HHPC firms for underperforming brands.

No Pain, No Gain
Adjusting to all of these changes hasn't been a picnic for HHPC firms, but without a doubt it's made them far healthier companies. Gross margins are improving across the board, and operating margins are trending upward, as well. Outsourced manufacturing, workforce reductions, and divested brands have all contributed to reduced overhead costs.

Just as importantly, the firms have worked to improve their capital structures over the past several years, taking advantage of undervalued shares. From 2004 to 2006 Newell Rubbermaid and Playtex reduced their long-term debt, for example, while Energizer aggressively bought back $600 million of its shares in fiscal 2006, or more than 15% of total shares outstanding. When not buying back shares, many of the firms have returned cash to shareholders with their respectable dividend yields, including Colgate (1.92%), Kimberly-Clark (2.88%), Procter & Gamble (1.88%), Newell Rubbermaid (2.90%), and a recent increase from Clorox (2.40%). In fact, the best reason to recommend these firms--their consistent, copious cash flows--facilitates paying down debt, buying back shares and issuing dividends.

What (and When) to Buy
For most of the firms in the HHPC sector, the market has appreciated this hard work, but that's no reason to completely take the stocks off the radar screen. In the event of a pullback in the market we'd happily ring up shares of many on our HHPC list, particularly those with wide moats, like P&G (which we think is already quite cheap), and Colgate, or narrow moats like Clorox, Kimberly-Clark, and Energizer. Their operations are in better shape now than they were two years ago and they've adjusted to a new reality of higher commodity costs.

Even in tough environments, many of these HHPC firms demonstrate the ability to deliver healthy sales and earnings growth. These are the companies that are adept at consumer trade-up, such as P&G with its Gillette Fusion razor or Kimberly-Clark with its Huggies Premium diapers, and they possess a deep understanding of their product categories. Alberto-Culver, for instance, introduced Nexxus, a lagging salon brand, to successful sales growth in the retail channel based on its grasp of consumer willingness to pay a premium for a more "upmarket" brand in the category.

Moreover, many of the HHPC firms are well positioned overseas in developing markets, which is where much of the growth in the industry will come from. For those looking to take advantage of this growth, and a falling dollar, P&G, Kimberly-Clark, and Colgate, are a terrific, indirect way to obtain some international exposure. P&G generates almost 57% of total sales outside of the United States, and Kimberly-Clark almost 44%; Colgate has a whopping 75% of total sales coming from international markets. People around the world stock their pantries with the brands of these companies, and after several difficult years, we believe there's even more reason now to keep these firms on the shopping list and wait for a sale.

Lauren DeSanto does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.