P&G Reports Moderate Q3 Results, Lays Out Future Growth Strategy

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Procter & Gamble

Global consumer processed goods behemoth Procter & Gamble (NYSE: PG) reported moderate third quarter results on April 23rd. (P&G follows July-June fiscal year.). The company continued to take a beating from currency headwinds, which dragged down its revenues to $18.1 billion in the third quarter, a decline of 8% year on year. Excluding the impact of currency movements, acquisitions, and divestitures, organic (non-GAAP) sales growth was a moderate 2% year on year. Operating margins fared slightly better, as cost savings from productivity improvements propelled the third quarter’s operating margin by 50 basis points to 17.3%. Core (non-GAAP) EPS contracted by 8% year on year due to the lower revenues base, and fell to $0.92 in the third quarter.

Moderate financial performance aside, the highlight of the quarter was the detailed growth strategy mapped out by CFO Jon Moeller in the earnings call. [1] Moeller emphasized that Procter & Gamble’s future revenue growth will be derived from its largest brands in its core business segments. The company will also trim its product lines and bring its SKU’s (stock keeping unit) down to a manageable level. Further, Moeller also detailed P&G’s three-pronged cost savings program, which includes 18 new manufacturing sites in developing markets, supply chain transformation in the US, lower marketing expenses.

We are currently revising our price estimate of $83 for Procter & Gamble, which is nearly the same as its current market price.

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See our complete analysis for Procter & Gamble here

Billion-Dollar Brands to Drive Future Growth

As expected, CFO Jon Moeller utilized the third quarter earnings call to provide a roadmap of P&G’s growth over the medium term. He reinforced the company’s belief that P&G’s future lies in its biggest brands, rather than the assortment of hundreds of smaller brands that it has accumulated over the past decade. According to P&G, the company’s category-leading billion-dollar brands have grown at a faster pace than its smaller brands. [1] This fact stands true over a 10-year, 5-year, 1-year and even on a quarterly basis. Therefore, P&G would be well served by focusing on these brands alone rather than trying to improve the performance of its smaller brands.

Focus on category-leading brands forms the core of P&G’s brand consolidation program. Following the completion of the brand divestments, P&G will have a far more focused portfolio and its remaining brands will dominate their respective categories and geographical markets. The company will also reduce its product lines by 15% to 20% to create a more efficient product line that will be easier to manage.

P&G also indicated that it may focus more on the premium category, which it believes is the key driver for growth in a product category. We believe that this may be a risky move in the near term, given the current volatile macroeconomic scenario and sluggish consumption growth across developing as well as developed markets. Over the long term, as the macroeconomic scenario improves and consumption picks up, consumers will be likely to switch upwards to premium category brands, which could benefit P&G.

Price Hikes Fail to Protect Top-Line from Currency Headwinds

Procter & Gamble’s revenues declined in all its business units compared to the previous year, owing to an 8% drag from adverse foreign exchange movements. In an attempt to counter sluggish consumption and currency devaluation in emerging markets, P&G hiked prices across all divisions except Fabric and Home Care. This provided a modicum of relief to the company as increased pricing contributed 2 percentage points to top-line expansion. Additionally, a greater proportion of higher-priced products in P&G’s product mix delivered another percentage point towards revenue growth.

However, as we previously postulated, higher prices may have set back volume growth even further as consumers switched to lower priced products offered by P&G’s rivals. The volume expansion may also have been restricted due to sluggish growth in consumption in emerging markets. Consequently, volumes contracted in all divisions other than Grooming during the third quarter.

Margins Expand on Robust Cost Savings

Following in the footsteps of its rival Unilever (NYSE:UL), P&G seems to trained its sights on bottom-line expansion. Given the limited potential for revenue growth in the present hostile macroeconomic scenario, cost savings are the most efficient way to protect short-term shareholder value.

P&G utilized productivity improvements to expand its gross margin as well as operating margin in the third quarter, both of which were higher sequentially. However, compared to the same period previous year, the gross margin of 48.6% was lower by 30 basis points, while operating margin of 17.3% was higher by 30 basis points. It should be noted that these metrics are after including the impact of adverse currency movements, which exerted significant downward pressure on the gross margin as well as operating margin.

Cost savings were driven primarily by savings in SG&A expenses in the third quarter. SG&A as a percentage of sales declined by 80 basis points year on year due to lower overhead and marketing expenses. P&G is aggressively moving towards achieving higher efficiency in its marketing expenses by shifting to digital to social media. [1] These efforts have clearly already started yielding returns in the form of significant cost savings. P&G believes that these are not just one-off improvements but are sustainable measures that are likely to deliver additional cost savings over the next few quarters.

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Notes:
  1. Procter & Gamble Fiscal 2015 Third Quarter Earnings Call Transcript, Seeking Alpha, April 23, 2015 [] [] []