ROA Matters: Why P&G, Nestle and Danone Are In Trouble
Raphael Savalle writes articles about the Consumer Goods sector, its strategic challenges and opportunities to help executives think about their options and to engage managers in thinking strategically. Savalle believes that there is a strong benefit to link strategy, finance and business operations with an analytical approach to focus leadership on their company’s opportunities and challenges.
The following is an excerpt from his article "Why do FMCG's CFOs care about ROA and why should you?," which is the 4th article in his series on Total Shareholder Return (TSR):
As a manager, you are entrusted with the company’s Assets. The primary measure of performance is the Return you are getting from these assets: How much after-tax money can you generate in one year? This ratio is called Return on Assets: ROA.
Return on Asset (ROA) for the Top 25 Consumer Goods companies.
Let’s look at the Return on Asset (ROA) for the Top 25 Consumer Goods companies. (Click here for the full article and charts.) This figure is the percentage a company earns on its assets in a given year. The calculation is net income divided by average total assets. ROA shows how much profit a company generates on its asset base. The better the company, the more profit it generates as a percentage of its assets.
The low performers are General Mills, Kellogg, Danone, Kraft Heinz, Conagra and P&G. Now you understand why P&G is in trouble: Asset heavy and average profitability. I skip on Avon, which is getting close to being bankrupt.
High performers: Mondelez, Clorox and Estee Lauder. Reckitt, GSK and Johnson & Johnson are a bit in a different league as they have a significant share of their portfolio in healthcare. Still, their performance is remarkable.
What are the drivers of this performance?
Why is Kellogg or P&G underperforming and how is Colgate or Reckitt doing so well?
Let’s look at the component of ROA. In effect, there are two components of ROA: Return on Sales (ROS) and Asset Efficiency (Asset Turnover). So let’s look at both components of ROA for our Top 25 Consumer Goods companies. It is interesting to see how some companies drive most of their ROA from ROS, like Reckitt or Mondelez – two companies with a very similar approach and how others like Colgate or Clorox drive most of their ROA from Asset efficiency. The performers with low ROA (actually ROAs between 4% and 8%): P&G, Nestle, Danone, Kellogg, General Mills.
If you follow my articles, you start to understand why these companies are in trouble with low Total Shareholder Returns. P&G, Danone (BSN), Kellogg and General Mills (GIS) need to pursue and accelerate their work on profitability. Most of them are doing Zero Base Budget initiatives (it’s the new trend and you see why) but they should not forget Price and Promotion optimization or innovation management. Now you understand why P&G, Nestle, Danone were among the worst performer in our Total Shareholder Return article.
Profitability Driven: We find on the left side, the company which are focusing heavily on their profitability. Some may be surprised by the low Asset Turnover of Reckitt. I believe it is partially driven by the acquisitive nature of Reckitt, which keeps its Asset value more up to date than other Companies. This is also the result of a heavy focus on the P&L at Reckitt.
Asset Turnover driven: We find on the right side the companies like Clorox, Colgate, Kimberly Clark which focus heavily on Asset Turnover (factory efficiency, low inventory ..etc). Estee Lauder is the clear outlier here … I believe Estee Lauder has still significant opportunities to improve its profitability.
Finally the Balanced Performers: If you have been following my other articles, you will find (again!) the great performer: L’Oral, Henkel, Beiersdorf, Church & Dwight, Dr Pepper Snapple – Well done!
You will see PepsiCo at the frontier between a good performer and under-performance: I believe Indra Nooyi has done a major shift at PepsiCo and this is costing a bit of performance for now to better position this company for better and healthier future growth … lets see!
Now, let’s look back at the chart and think “what would it take for Mondelez or Reckitt to further improve its ROA?” What is interesting is which path to choose to improve your ROA: you can strive to improve your profitability (ROS) and move vertically or focus on Asset Turnover and move towards the right of the chart.
Reckitt needs to maintain a good profitability but will have to focus now on the Asset Turnover and move towards the right of the chart. Mondelez Asset Turnover at 0.5, is half the performance of Campbell Soup to move from 11% ROA to 14% (a 27% improvement), Mondelez would need to either improve its Asset Turnover by 27% from 0.46 to 0.58 or its Net Profitability from 24.5% to 31.1%.
You can easily answer the same question now for Kimberly Clark: their categories are being commoditized and unless KMB improves its profitability through cost reduction (SG&A), better innovation for improved pricing, it will be difficult to continue working on Asset utilization to improve the Total Shareholder Returns.
What is very surprising to me is the difference between the low performance of Nestle and P&G and Unilever or Colgate especially for Asset Turnover.
More Fun with ROA?
This was fun, but we can have some more… Delivering Total Shareholder Return is about beating Financial Market’s expectation. What I mean by that is that you can actually deliver a very high TSR from what looks like an underperforming position only by showing improvement on your fundamentals (Revenue growth, Profitability, ROA) which the market is not initially expecting. It goes both ways… your Share price and TSR will dive for any “bad surprise”, because the market expects you to deliver the same performance. This means that it would be interesting to look at the changes for our top 25 companies in the past few years to see how it correlate with their TSR percent - Ready?
Winners: You can see how the top TSR performers have climbed the ROA mountain in the past 5 years (2015 vs. 2010). Impressive results again for L’Oral, Henkel, Estee Lauder, Church & Dwight, Dr Pepper and Beiersdorf. To improve their ROA, most of this companies chose to prioritize Net Margin vs. Asset Turnover. This is driven by the extremely low interest rates which renders Asset efficiency less critical.
Under-Performers: The reduction in ROA and under-performance is clear. It correlates with the TSR performance as well. The outliers (Conagra, General Mills and Kimberly Clark) have offset their lackluster ROA performance with an increase in financial leverage (Debt), which allowed them to deliver decent TSR…for now. General Mills and Conagra could well end up as acquisition target for a renewed Kraft-Heinz.
Finally, the rest of the pack: Most of the companies went downhill. Chasing the P&L profitability improvement has been fruitless and will not bring further ROA improvement. Colgate had a steep downhill from 18 percent+ to 11 percent degrading both its profitability and Asset Turnover. Colgate has been increasing its debt load to use Finance leverage to maintain its TSR (with Share buy back). Colgate should fast recover their profitability. (Cost cutting, Pricing, Better innovation, efficient A&P spending, reduced SG&A…etc)… or get acquired by Unilever or? Mondelez had a terrific past few years for their profitability and they should now seek to increase their ROA through better Asset utilization.
I hope you now understand why P&G, Nestle, Danone are in trouble, how L’Oral, Henkel, Estee Lauder, DPS and CHD are performance rock stars, how some other like Kimberly Clark, Colgate are fighting to fend off their profitability slide, how Mondelez should focus more on Asset Utilization and how Estee Lauder is an outlier with its relatively low profitability.
The following is an excerpt from his article "Why do FMCG's CFOs care about ROA and why should you?," which is the 4th article in his series on Total Shareholder Return (TSR):
As a manager, you are entrusted with the company’s Assets. The primary measure of performance is the Return you are getting from these assets: How much after-tax money can you generate in one year? This ratio is called Return on Assets: ROA.
Return on Asset (ROA) for the Top 25 Consumer Goods companies.
Let’s look at the Return on Asset (ROA) for the Top 25 Consumer Goods companies. (Click here for the full article and charts.) This figure is the percentage a company earns on its assets in a given year. The calculation is net income divided by average total assets. ROA shows how much profit a company generates on its asset base. The better the company, the more profit it generates as a percentage of its assets.
The low performers are General Mills, Kellogg, Danone, Kraft Heinz, Conagra and P&G. Now you understand why P&G is in trouble: Asset heavy and average profitability. I skip on Avon, which is getting close to being bankrupt.
High performers: Mondelez, Clorox and Estee Lauder. Reckitt, GSK and Johnson & Johnson are a bit in a different league as they have a significant share of their portfolio in healthcare. Still, their performance is remarkable.
What are the drivers of this performance?
Why is Kellogg or P&G underperforming and how is Colgate or Reckitt doing so well?
Let’s look at the component of ROA. In effect, there are two components of ROA: Return on Sales (ROS) and Asset Efficiency (Asset Turnover). So let’s look at both components of ROA for our Top 25 Consumer Goods companies. It is interesting to see how some companies drive most of their ROA from ROS, like Reckitt or Mondelez – two companies with a very similar approach and how others like Colgate or Clorox drive most of their ROA from Asset efficiency. The performers with low ROA (actually ROAs between 4% and 8%): P&G, Nestle, Danone, Kellogg, General Mills.
If you follow my articles, you start to understand why these companies are in trouble with low Total Shareholder Returns. P&G, Danone (BSN), Kellogg and General Mills (GIS) need to pursue and accelerate their work on profitability. Most of them are doing Zero Base Budget initiatives (it’s the new trend and you see why) but they should not forget Price and Promotion optimization or innovation management. Now you understand why P&G, Nestle, Danone were among the worst performer in our Total Shareholder Return article.
Profitability Driven: We find on the left side, the company which are focusing heavily on their profitability. Some may be surprised by the low Asset Turnover of Reckitt. I believe it is partially driven by the acquisitive nature of Reckitt, which keeps its Asset value more up to date than other Companies. This is also the result of a heavy focus on the P&L at Reckitt.
Asset Turnover driven: We find on the right side the companies like Clorox, Colgate, Kimberly Clark which focus heavily on Asset Turnover (factory efficiency, low inventory ..etc). Estee Lauder is the clear outlier here … I believe Estee Lauder has still significant opportunities to improve its profitability.
Finally the Balanced Performers: If you have been following my other articles, you will find (again!) the great performer: L’Oral, Henkel, Beiersdorf, Church & Dwight, Dr Pepper Snapple – Well done!
You will see PepsiCo at the frontier between a good performer and under-performance: I believe Indra Nooyi has done a major shift at PepsiCo and this is costing a bit of performance for now to better position this company for better and healthier future growth … lets see!
Now, let’s look back at the chart and think “what would it take for Mondelez or Reckitt to further improve its ROA?” What is interesting is which path to choose to improve your ROA: you can strive to improve your profitability (ROS) and move vertically or focus on Asset Turnover and move towards the right of the chart.
Reckitt needs to maintain a good profitability but will have to focus now on the Asset Turnover and move towards the right of the chart. Mondelez Asset Turnover at 0.5, is half the performance of Campbell Soup to move from 11% ROA to 14% (a 27% improvement), Mondelez would need to either improve its Asset Turnover by 27% from 0.46 to 0.58 or its Net Profitability from 24.5% to 31.1%.
You can easily answer the same question now for Kimberly Clark: their categories are being commoditized and unless KMB improves its profitability through cost reduction (SG&A), better innovation for improved pricing, it will be difficult to continue working on Asset utilization to improve the Total Shareholder Returns.
What is very surprising to me is the difference between the low performance of Nestle and P&G and Unilever or Colgate especially for Asset Turnover.
More Fun with ROA?
This was fun, but we can have some more… Delivering Total Shareholder Return is about beating Financial Market’s expectation. What I mean by that is that you can actually deliver a very high TSR from what looks like an underperforming position only by showing improvement on your fundamentals (Revenue growth, Profitability, ROA) which the market is not initially expecting. It goes both ways… your Share price and TSR will dive for any “bad surprise”, because the market expects you to deliver the same performance. This means that it would be interesting to look at the changes for our top 25 companies in the past few years to see how it correlate with their TSR percent - Ready?
Winners: You can see how the top TSR performers have climbed the ROA mountain in the past 5 years (2015 vs. 2010). Impressive results again for L’Oral, Henkel, Estee Lauder, Church & Dwight, Dr Pepper and Beiersdorf. To improve their ROA, most of this companies chose to prioritize Net Margin vs. Asset Turnover. This is driven by the extremely low interest rates which renders Asset efficiency less critical.
Under-Performers: The reduction in ROA and under-performance is clear. It correlates with the TSR performance as well. The outliers (Conagra, General Mills and Kimberly Clark) have offset their lackluster ROA performance with an increase in financial leverage (Debt), which allowed them to deliver decent TSR…for now. General Mills and Conagra could well end up as acquisition target for a renewed Kraft-Heinz.
Finally, the rest of the pack: Most of the companies went downhill. Chasing the P&L profitability improvement has been fruitless and will not bring further ROA improvement. Colgate had a steep downhill from 18 percent+ to 11 percent degrading both its profitability and Asset Turnover. Colgate has been increasing its debt load to use Finance leverage to maintain its TSR (with Share buy back). Colgate should fast recover their profitability. (Cost cutting, Pricing, Better innovation, efficient A&P spending, reduced SG&A…etc)… or get acquired by Unilever or? Mondelez had a terrific past few years for their profitability and they should now seek to increase their ROA through better Asset utilization.
I hope you now understand why P&G, Nestle, Danone are in trouble, how L’Oral, Henkel, Estee Lauder, DPS and CHD are performance rock stars, how some other like Kimberly Clark, Colgate are fighting to fend off their profitability slide, how Mondelez should focus more on Asset Utilization and how Estee Lauder is an outlier with its relatively low profitability.
Raphael Savalle was recently the VP Finance for the Global Operations division at Coty, a $4.5 Billion beauty leader, leading major effort to improve Coty’s operations’ performance, reduce the cost base and consolidate the factory network. The work we led on change management was featured in a Harvard Business Review article (“How Coty reinvigorated its Supply Chain”) and in a book “Accelerate” by Harvard University Prof. Kotter.
His earlier experience was in Management Consulting in Europe with Deloitte Consulting and in Bankruptcy restructuring for a $2.5 Billion Retailer in the USA. He graduated from the Kellogg School of Management in Chicago with a MBA in Strategy, Finance and Marketing, and earned a Master of Science in Industrial Organization from Ecole Nationale des Ponts et Chaussees in Paris and an Engineer Diploma from Institut National Polytechnique in Toulouse.