Emerging Markets Will Continue To Lead Procter & Gamble’s Growth, Beauty Has A Moderate Outlook

Procter & Gamble (NYSE:PG) posted a 4% year-over-year increase in organic sales (excludes the impact of acquisitions/disposals and foreign currency movements) in Q1 FY 2014, at the higher end of its guidance, on the back of 8% organic sales growth in the emerging markets.(Fiscal years end with June.)  While the company’s fabric & home care segment, and baby, feminine & family care segment each registered organic sales growth in excess of 5% year over year, its beauty, grooming and healthcare segments under-performed with only 0-1% increase in organic sales. For further insights on P&G’s Q1 FY 2014 performance, read our article: Procter & Gamble Marks A Healthy Start To The Fiscal Year Despite Slow Growth In Beauty

P&G is set to release its earnings for Q2 FY 2014 on Friday, January 24th. We expect the company to post organic sales growth in the range of 3% to 5% led by the emerging markets. However, this will translate into lower net sales growth due to foreign exchange losses pertaining to currency weaknesses in the emerging economies. We also expect the company to post an increase in gross margins driven by its efforts to cut costs.

Our price estimate for Procter & Gamble’s stock stands at $73, about 10% lower than its market price.

P&G Is Trying To Get Beauty Division Back On Track

About 25% of P&G’s revenues come from beauty products. The company’s beauty portfolio includes iconic brands like SK-II, Hugo Boss, Dolce & Gabbana, Gucci, Lacoste, James Bond 007, Head & Shoulders, Olay and Pantene.

Despite being a major competitor in the global prestige beauty and fragrance market, the company’s beauty organic sales increased by only 1% year over year in Q1 FY2014 due to heavy competitive product and promotional activity. Some of P&G’s beauty products performed weaker than others in the quarter. For instance, while personal cleansing, cosmetics and deodorants witnessed healthy organic sales growth, skin care sales declined during the quarter. The management feels that its salon professional business also requires increased focus. ^[1]

P&G is trying to bring its beauty business back on track. It has built a strong pipeline of innovations with many launches expected in the third quarter. Earlier this month, the company announced the launch of a new ad campaign for Olay (P&G’s premium beauty brand) that spans across its boutique brands. ^[2] It has also brought back A.G. Lafley on board as the new CEO. Under his leadership during 2000–2009, the company transformed into a major beauty player by divesting many low profitability businesses, acquiring  hair care players such as Wella AG and Clairol, and reinventing Olay to make it a billion-dollar brand.

Based on these factors, we estimate P&G will gain share in the beauty market going forward. However, the increase will be marginal due to high competition in the segment, adverse affects of product mix in emerging markets, and cost-saving measures that may eat into the company’s marketing budgets.

Cost Savings And Restructuring Activities To Support Gross Margins

In recent years, P&G has taken significant steps to enhance productivity, including a five-year cost savings initiative that will last until 2016. Through the initiative, P&G aims to save $10 billion in costs associated with goods sold, marketing expenses and non-manufacturing overhead. The program helped the company to save $1.2 billion in cost of goods sold in FY 2013.

Reducing energy costs is one area where P&G has done well. In 2010, the company revealed a sustainability program to drive 20% reduction in energy usage per unit of production by 2020. The company has reduced energy consumption by 8% thus far, and continues to introduce energy management systems at new locations that will help it save millions of dollars. According to a recently published report by Bloomberg, P&G is also planning to restructure its global business units and that should help it achieve its cost savings target. (Read: Procter & Gamble Seems To Be On Track To Achieve Its Cost Savings Target)

We believe that the cost savings and the restructuring program will help P&G to drive gross margin improvement, and to accelerate sales growth by providing scope for increasing investments in innovations and expansion opportunities.

See our complete analysis of Procter & Gamble

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1. P&G Delivers First Quarter Core EPS of $1.05, Organic Sales Up 4%, P&G Investor Relations Website, October 25, 2013 [↩]
2. P&G’s Olay Launches ‘Your Best Beautiful’ Campaign, Marketing Daily, January 10, 2014 [↩]