Volumes Drive Upside for P&G

Procter & Gamble (NYSE:PG), the world’s leading consumer goods company, recently reported results for its fiscal third quarter. P&G continued to drive volumes in emerging markets at competitive prices, matching our expectations. P&G competes with other leading beauty and personal care companies such as Unilever (NYSE:UL), Colgate-Palmolive (NYSE:CL) and Kimberly-Clark (NYSE:KMB).

We value Procter & Gamble at a $75.25 stock price estimate, a roughly 15% premium to market price.

Q3 2011 Highlights

Volume-Driven Growth

As we had expected ^[1], the company broadly delivered volume-driven growth, with volumes rising 5% over January-March 2011 compared to the same period last year. While price increases helped to counter rising commodity costs, they could not entirely save gross margins, which shrunk by almost 1.4%. They did, however, partially offset the impact of an increased mix of sales from lower priced products in emerging markets like Asia and Latin America.

Increasing Operating Expenses

In addition to rising raw material costs, an increase in selling, general and administrative expenses by almost 0.7% also squeezed operating margins. This effect was driven by higher advertising for product launches in new geographic regions. Of the 38 product categories in which P&G competes globally, it is present in only 14 on average in Asia and only 12 in India, ^[2] a market growing consistently at double-digit rates. Plans to launch more products in more markets will spur increased expenses and further strain operating margins over the near-term. But with rising volumes, the effect of increased operating expenses is somewhat mitigated.

What to Expect in the Remaining Fiscal Year?

P&G has been utilizing timely price increases to absorb rising commodity costs, while still managing to maintain market share. As inflation cools down, we can reasonably expect gross margins to improve, although improvements in operating margins could be muted.

Accessing new consumers in emerging markets poses a challenge in terms of the costs associated with marketing, advertising, product customization to suit local tastes and distribution. But as these consumers gradually shift towards higher-priced brands within P&G’s portfolio, it could unlock long-term growth potential. Hence despite reduced margins, P&G is still on the right track as long as volumes keep coming in.

See our complete analysis for P&G stock here