All Eyes on P&G’s Brand Consolidation Strategy as Currency Headwinds Weigh on Q2 Results

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Procter & Gamble

Global consumer brands behemoth Procter & Gamble (NYSE: PG) is set to release its 2015 second quarter results on January 27th (the company follows July-June fiscal year). Following the lackluster performance in the first quarter, P&G is guiding second quarter organic sales to grow by low to mid-single digits. Core (non-GAAP) EPS is guided to grow by the same range, despite currency headwinds of 5 to 6 percentage points. It is pertinent to note that the company provided this guidance assuming mid-October spot rates. [1] Given the deterioration in major currencies since then, including the Euro, Ruble, Bolivar and Real, second quarter currency headwinds may be at the higher end of P&G’s guidance.

This also marks the first quarterly results since P&G announced its ambitious plan to trim its nearly 200-strong portfolio of brands down to 70-80 core brands. Additional details of the closely watched strategy and follow-up on the divestments so far are likely to be announced with the earnings.

P&G’s revenue in the first quarter was $20.79 billion, marginally lower than the same period the previous year. GAAP operating income was pulled down by impairment charges of nearly $1 billion and fell to $2.9 billion, declining 29% year on year. On a non-GAAP basis, operating profit margin stood at 19.9%, slightly lower than 20.1% in Q1 2014. It was overall a disappointing performance as volume and pricing growth, as well as cost savings, were wiped out by currency headwinds.

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Brand Shedding Continues in Earnest

Procter & Gamble followed up the announcement of its brand portfolio consolidation plan by selling a few of its well-known but (in some but not all cases) poorly performing brands. In November, the company sold off Duracell, a leading battery brand, to Berkshire Hathaway in a $3 billion dollar deal. Having sold off its China-based batteries joint venture, the sale of Duracell marked P&G’s exit from the batteries business. (Read: Personal Care Companies Shed Weight In 2014)

More recently, in December the company announced the sale of its Camay and Zest soap brands to Unilever (NYSE: UL) for an undisclosed amount. (Read: P&G Unloads Camay and Zest Brands to Unilever) Moreover, P&G is also rumored to be exploring options for divesting the Wella hair care unit, a business that is estimated to be valued around $7 billion. Its Braun unit, which makes electric razors and toothbrushes, is also rumored to be up for sale. [2]

Thus, P&G seems to be willing to divest not just non-core brands like Duracell, but also brands that form part of its core business, like Wella, regardless of their revenue share. This indicates that the company’s focus is not on the top line but on its margins; and the primary criteria for brands that it will continue are profitability and growth potential. This bodes well for investors, since improved bottom lines will add firepower to P&G’s strong track record of increasing returns to shareholders. However, GAAP margins may suffer in the short term due to impairment charges and disposal-related costs incurred over the duration of the brand consolidation strategy.

Given that P&G intends to wrap up the ambitious plan in a relatively small period of 18-24 months, it is likely that the company will provide further details on the same in its second quarter earnings report.

Market Share Gains Through Product Innovation May Partially Offset Currency Headwinds

Gaining market share by regularly introducing new innovative products is a hallmark of Procter & Gamble. The company introduces a large number of new products every quarter and has gained market share in each of its core businesses. Notably, P&G entered the premium diapers, feminine hygiene and adult incontinence categories in the second quarter as demand in the premium category is seeing an uptick in the developed markets. With this, it issued a direct threat to Kimberly-Clark (NYSE: KMB), which leads is the market leader in each of these segments.

P&G has stated that it will combine brand consolidation with targeted innovation investments in its core categories. [1] Thus, while brand consolidation will drive bottom line improvement over the long term, increase in investments in innovation will bolster top line growth. The company intends to further support top line growth by targeted reinvestments in core businesses. It has already put this strategy into action by increasing marketing support in the U.S. to its Tide and Campus brands by 60 basis points and 230 basis points, respectively.

The above measures might provide a modicum of relief to revenue growth, which has been battered by strong currency headwinds since the second half of calendar 2014. Adverse currency movements in key emerging markets like Russia, Brazil, Venezuela and Hong Kong, among others, pulled down first quarter revenue growth by one percentage point. This impact is expected to worsen in the second quarter, especially considering that P&G provided its revenue guidance based on mid-October foreign exchange spot rates rather than forward rates.

Cost Savings to Prop-up Core EPS

Procter & Gamble has been keeping a steadfast check on its costs over the last few quarters and has succeeded in preserving profit margins despite currency headwinds and commodity cost inflation. Its gross margin improved by 20 basis points in the first quarter, thanks to a substantial cost savings of 140 basis points. This more than offset currency headwinds, commodity cost inflation and negative margin mix impact. Cost savings were driven by 70 basis points of savings in overheads and 50 basis points in marketing.

These measures trickled down to the core EPS, which expanded by 2% year on year in the first quarter. The improvement in core EPS is all the more noteworthy considering that the company’s revenue declined slightly in the first quarter, compared to the same period previous year. In other words, P&G was able to ensure protection of shareholder value despite a fall in top line.

Going forward, P&G is on an accelerated track for achieving its goal of $10 billion in cost savings, which it set 2012. It also expects to exceed its target of annual $1.2 billion savings in cost of goods by a substantial margin this year. Manufacturing productivity is expected to increase by 6% in fiscal 2015; and global supply chain restructuring efforts are targeted to achieve $1 billion to $2 billion in value creation. [1]

In light of the above factors, we believe that P&G may be able to ward off much of the negative impact from adverse currency movements through its robust cost saving efforts.

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Notes:
  1. Procter & Gamble Q1 2015 Earnings Call Transcript, Seeking Alpha, October 24, 2014 [] [] []
  2. P&G exploring sale of $7 billion Wella hair care unit, Reuters, November 28, 2014 []