P&G Earnings Preview: Focusing on Volume Growth

Procter & Gamble (NYSE:PG) plans to release earnings this Friday. P&G competes with other leading players in personal care such as Unilever (NYSE:UL), Kimberly-Clark (NYSE:KMB) and Colgate-Palmolive (NYSE:CL), and markets will watch these consumer goods bellwethers for signs on spending trends and inflationary concerns.

We value Procter & Gamble with a $68.40 Trefis price estimate of its stock, at almost a 10% premium to its current market price. In the upcoming earnings we’re less worried about margins and looking for volume growth give the company’s ambitious goals to penetrate new markets.

Why Margins are Less of a Worry

P&G embarked on its ambitious goal to acquire a billion additional consumers by 2014/15, which naturally drew its focus to the two most populous nations in the world – China and India. To cater these high-growth but low-income level consumer market, P&G has had to launch low-priced and smaller-sized variants of its products, expand its distribution network to reach out to the consumers in the remote parts of country and enter more product categories in these countries — all of which are likely to have considerably increased operating expenses.

For instance, out of the 38 product categories in which P&G competes globally, it is present in only 19 on an average globally, 14 on an average in Asia and only 12 in India. See India is Key to P&G’s Additional Billion Customer Goal. P&G has elaborate plans to launch more of its products in more markets, which is bound to increase marketing and selling expenses and strain the operating margins in the short term, at least until volumes pick up.

To add to this, the rising commodity prices are expected to have further strained gross margins and given the highly price-conscious consumer in these markets, passing the rise in costs to the consumers in the form of price hikes is not easy either.

Hence, we expect some margin compression —  or at best maintain at current levels in the upcoming earnings release.

Promotional Activities to Hit Gross Margins

Much of P&G’s success in gaining scale in these new markets depends on pricing its products at parity with local competition though its seen as a premium brand. Promotional pricing and a higher proportion of its sales coming from the lower-priced variants in these high-growth markets are expected to have a negative impact on the average price levels.

Currency impact could further significantly dent the dollar value of sales as well as the swelling U.S. fiscal deficit put downward pressures on the dollar combined with the appreciating Chinese Yuan and Indian Rupee are expected to translate into a lower dollar value of sales.

Volumes are the Key Indicator

P&G is essentially targeting high volumes to compensate for low margins and reduced average prices of its products. Accessing new consumers poses the biggest challenge in terms of the costs associated with marketing, advertising, product customization and distribution. But as these consumers gradually tier up to higher-priced brands within P&G’s portfolio, it unlocks long-term growth potential.

Hence, for these investments in emerging markets to put P&G on the promised, long-term growth trajectory, the company must show some volume growth even at the expense of margins.

View our detailed analysis for P&G here.