P&G Primed For $73 If Earnings Can Show Margin Improvement

Procter & Gamble (NYSE:PG) will announce its third quarter results this Friday. With slow market volume growth and higher input commodity and energy costs, the company’s earnings have been depressed over the last few quarters despite pricing efforts. With continued weak demand and high cost environment, the consumer giant is trying to rely less on pricing and more on streamlining its cost structure to recover margins. It recently announced plans to cut its costs by $10 billion in the next five years and invest the released resources in emerging markets and personal care segments. P&G competes with other leading players in the personal care segment such as Unilever (NYSE:UL), Kimberly-Clark (NYSE:KMB) and Colgate-Palmolive (NYSE:CL).

See our complete analysis for Procter & Gamble’s stock

Margins In Focus

Increasing prices of commodity and energy, the key inputs to manufacturing for P&G, adversely affected the company’s gross margins in 2010 and 2011. The margins were also offset by slow growth in the developed markets and disproportionate growth in developing regions, which have lower than segment average selling prices and lower demand for premium-priced products, leading to adverse product mix and downward pressure on margins. Even though P&G continued to increase prices every quarter to offset the pressure on its gross margins, even at the cost of some market share, the company-wide EBITDA margins fell from 26.5% in 2009 to 23.9% in 2010 and 22.3% in 2011.

With No Respite On Input Cost Front, Focus On Massive Cost-Cuts

The input-cost inflation trends are likely to continue and volume growth is likely to continue being depressed by slowing growth in developed markets and rising prices. Volume sales of fast moving consumer goods are highly sensitive to price and any attempt to recover lost margins through higher pricing may immediately lead to consumers trading down to cheaper alternatives and loss of market share.

With pricing constraints and not much optimism around easing of the commodity cost environment, P&G is now focusing on cutting its costs to improve its margins. In February 2012, it announced plans to save $10 billion in costs by 2016, which would include $1 billion reduction in marketing costs and $3 billion in overhead expenses. It plans to eliminate more than 4,000 jobs and rationalize its massive marketing budget in an effort to streamline its cost structure that has weighted on profit margins. It is likely to cut 1,600 jobs in the current fiscal year. These cost cuts will significantly help the company improve its margins going forward.

We value Procter & Gamble with a $73 Trefis price estimate of its stock, at a near 10% premium to its current market price.

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