P&G Q1’15 Preview: Markets Slowdown And Currency Headwinds Should Test P&G Brands

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Procter & Gamble

Procter & Gamble (NYSE:PG) is scheduled to report its Q1FY15 results on October 24. Last fiscal year, sales for the world’s largest consumer goods company stood at $83 billion, marginally higher than sales from fiscal year 2013. (Fiscal years end with June.)  Company-wide product volumes witnessed a 3% growth in FY14 while currencies had a negative impact of 2% during the period. P&G’s two largest business units (fabric & home care and baby, feminine & family care) had the highest growth rates in volumes across all business units. Product volumes from the fabric care business segment registered a 5% growth rate. Similarly, the baby, feminine and family care business unit registered a 4% growth in year on year volumes. However, growth in these business units in reported terms was restricted by currency headwinds, which had a negative 3% impact.

Growth in the remaining business units of beauty, grooming and health care was tepid, weighed down by weak market conditions in developed and emerging economies. The weakness in these business units was further attenuated by P&G’s many underperforming brands. Recently, The Wall Street Journal reported that P&G plans to sell more than half of its 200 brands to focus exclusively on profitable brands. [1] We expect to gain more clarity on this from the upcoming earnings conference call. Despite the weak top line performance, due to extreme currency volatility, P&G has managed to expand its margins on a year-on-year basis through prudent reductions in manufacturing and non-manufacturing overhead expenses. The operating profit margin for FY14 stood 1 percentage point higher over FY13, at 18.4%. Similarly, the net earnings margin (from continuing operations) expanded 40 basis points to 14.1% in FY14.

The company has an ambitious five-year plan lasting until fiscal year 2016 and expects to cumulatively save about $10 billion in cost of goods sold, marketing expenses and non-manufacturing related overhead. It saved $1.2 billion in cost of goods sold in FY2013 and delivered on its earlier guidance of saving $1.6 billion in cost of goods sold in FY2014. [2] We expect to see additional cost savings on these fronts that should create margin accretion in FY15.

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Sluggish Developed Markets to Weigh on Results

Last fiscal year, the U.S. accounted for more than 35% of total P&G sales and registered a meager 0.7% year on year growth. Comparatively, its International markets portfolio fared better in FY14, although reported sales only grew 0.6% year on year. This is because the reported sales from International economies were significantly depressed from currency fluctuations in these markets in FY14. P&G’s geographic portfolio is also skewed towards developed economies, unlike its competitors. North America and Western Europe alone accounted for 57% of total FY14 sales. This proportion for other U.S. based FMCG (i.e, Fast Moving Consumer Goods) majors such as Kimberly-Clark and Colgate stand at 50% and 44% year to date in 2014.

Although the domestic U.S. market looks to be gaining momentum, it is yet to deliver on results. In its latest quarterly presentation released October 23, 2014, Unilever reported that the North American market for FMCG products grew 1% on a year on year basis. [3] Market growth in Europe however was much disappointing and declined by over 2% last quarter due to significant price deflation in FMCG products. We expect tepid sales from P&G’s developed markets portfolio, weighed down by sluggish market growth and contracting economies. P&G has already witnessed a slowdown in its beauty product portfolio, especially among hair care, hair color and facial care products in developed markets.

Unfavorable Mix Could Curtail Emerging Market Volume Growth

In addition to slowing sales in developed markets, P&G has not been able to capitalize on its success in emerging markets due to its large brand portfolio. Volumes from markets excluding North America and Europe have remained robust. However, the proportion of overall sales from high growth markets such as Asia and Latin America have remained at 18% and 10%, respectively, for the last three fiscal year periods. We believe the reason for slacking sales, despite a surge in volumes, is an unfavorable mix of products in these markets.

For example, within fabric care, P&G has registered a high single-digit growth in volumes from developing markets and a low single-digit growth in volumes in developed markets. Despite this volume expansion, market share was flat in FY14. Likewise, P&G home care volumes in developing and developed markets in FY14 grew in the same range as fabric care last fiscal year. This resulted in a 50 basis point increase in market share in home care in FY14. Health care sales in FY14 faced a strong influence of unfavorable mix as geographic expansion in developing markets in low-priced product lines such as Vicks dragged down net sales. While in the long term, the expanding geographic reach of P&G products should lead to an acceleration in sales, unfavorable product-price mix could erode net sales in the near term.

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Notes:
  1. P&G to Shed More Than Half Its Brands, The Wall Street Journal, August 2014 []
  2. Goldman Sachs Consumer Products Symposium 2014, P&G Investor Relations, May 2014 []
  3. Unilever Trading Statement – Q3FY14, Unilever Investor Relations []