Innovation May Well Have Driven P&G’s Organic Growth Back to Positive Territory in Q2

Global consumer products powerhouse Procter & Gamble (NYSE:PG) is slated to report its fiscal 2016 second quarter earnings on January 26th.  (Fiscal years end with June). ^[1] P&G is expected to have achieved low-single digit organic revenue growth in the second quarter as the impact of its innovation efforts kicks in. As in the previous few quarters, pricing is expected to have contributed more than volume growth to the second quarter results. However, this time around the growth in pricing may be more a function of premium-heavy product mix rather than price hikes. ^[2] Further, Procter & Gamble’s numerous productivity efforts are likely to have provided additional support to the bottom-line in the second quarter. However, the extent to which such productivity efforts trickled down to the EPS would depend upon P&G’s level of reinvestments in R&D and marketing in the second quarter, also a focus for the company.

Procter & Gamble’s fiscal 2016 first quarter performance recap:

• Revenue declined by 12% year on year to $16.5 billion (1% decline on constant currency basis)
• Non-GAAP operating margin improved by 270 basis points year on year to 23%
• Non-GAAP EPS contracted by 1% year on year to $0.98

Our price estimate of $76 for Procter & Gamble is nearly the same as its current market price.

See our complete analysis for Procter & Gamble here

Innovation Efforts Could Pay Off in Q2

Procter & Gamble has been reinvesting a chunk of its savings from productivity improvements into R&D in an attempt to revive innovation in the company. (Read: Here’s Why Procter & Gamble Should Not Break Up) These innovations could have begun to pay off in the second quarter and are likely to pick up steam in the back half of fiscal 2016. ^[2] After a disastrous fiscal first quarter which saw the company’s organic growth plunging to negative territory, the sustained innovation efforts so far may play a crucial role in propping up the second quarter performance.

Further, pricing is expected to continue to remain the dominant factor behind driving organic revenue growth, with volume growth taking the back seat. But unlike in the previous few quarters, the higher contribution of pricing to organic revenue growth in the second quarter may be due to a premium-heavy product mix rather than price hikes. Procter & Gamble previously stated in the first quarter earnings call that most of the pricing activity has already been implemented and pricing may pare off in the back half of the year. ^[2] Thus, we believe that price hikes were moderate in the second quarter compared to the steep increases in the last few quarters. Instead, the growth in pricing was likely driven by innovation efforts focused on premium products, which would skew the product mix towards higher priced products. This trend is likely to continue and even strengthen in the second half of the fiscal year.

Margin Accretion Likely to Continue

Procter & Gamble has turned difficult macroeconomic conditions and the ongoing restructuring into an opportunity to carve out company-wide productivity improvements. This helped P&G improve its non-GAAP operating margin by a commendable 270 basis points year on year in the first quarter to 23%. (Read: A Deeper Look at P&G’s Q1 Results: Focus On The Bottom-Line Is Fine, But At What Cost?)

The trend likely continued in the second quarter also, as P&G was on or ahead of the track to achieve its productivity improvement targets. This includes delivering $7 billion in cost savings by the end of fiscal 2016, ahead of the original target of $6 billion. The company also revisited its marketing agency agreements last year, which is expected to provide $200 million in cost savings this fiscal year. ^[2] Simultaneously, Procter & Gamble has also reduced its inventory days, increased its payable days maintain strong free cash flow productivity. (Read: Can Procter & Gamble Return to Growth?)

It is possible that the benefits of these productivity improvements may not trickle down to the bottom-line in entirety. P&G has reiterated its intention to continue reinvesting in R&D in the coming quarters. The company’s marketing expenditure is also expected to increase in fiscal 2016, both in absolute terms and as a percentage of sales. Thus, the impact of productivity improvements may not be fully reflected in P&G’s bottom-line.

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1. Procter & Gamble Investor Relations [↩]
2. Procter & Gamble Fiscal 2016 First Quarter Earnings Call Transcript, Seeking Alpha, July 30, 2015 [↩] [↩] [↩] [↩]