P&G’s Near-Term Outlook Darkens as Volumes Drop in Q4

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PG: Procter & Gamble logo
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Procter & Gamble

Global consumer processed goods behemoth Procter & Gamble (NYSE:PG) appears to have put top-line growth on hold while it focuses on the ongoing organizational restructuring and productivity improvements. As per fiscal 2015 fourth quarter and full year earnings reported on July 30th, volumes plunged across the board in fiscal 2015 as the company raised prices to battle raging currency headwinds. [1] (P&G follows July-June fiscal year) We believe that P&G’s near term outlook remains weak since it continues to prioritize productivity improvements ahead of revenue expansion. As in the case of fiscal 2015, volatile currency movements are likely to wipe out future productivity savings, thereby dragging down overall performance in the near term.

In fiscal 2015, P&G raised prices in all its five divisions, leading to contraction in volumes across the board. The situation was worsened by heavy currency headwinds, which dragged revenue growth down by 6 percentage points. This brought P&G’s 2015 full year revenue down to $76.3 billion, which is a decline of 5% compared to the previous year.

The performance was no better on the margins front as the benefit of 130 basis points derived from productivity enhancements was fully wiped out by adverse currency movements. Coupled with a one-time charge of $2.1 billion for an accounting change in the Venezuela subsidiary, diluted GAAP EPS plunged by 39% year on year to $2.44.

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P&G’s performance is not expected to improve in the near term as the company has openly stated that it intends to continue focusing on organizational restructuring and productivity improvements, while putting revenue growth on the backburner. [2] Sustained currency headwinds are likely to exacerbate an already difficult situation for the company. It is possible that P&G’s strategy may pay off in the long term and growth may revive once the ongoing structural changes are in place. Until such time, we believe that P&G is likely to underperform its peers like Unilever (NYSE:UL) and Kimberly-Clark (NYSE:KMB).

Our price estimate of $78 for Procter & Gamble is nearly the same as its current market price.

See our complete analysis for Procter & Gamble here

P&G Giving Preference to “Value Creation” over “Volume Growth”

We have previously stated that P&G’s  price hikes may be holding back its volume growth. In the fourth quarter conference call, CEO A.G. Lafley defended the strategy by advocating long term value creation over short term volume and market share growth. Indeed, CFO Jon Mueller went as far as to state outright that in a scenario where P&G has to pick between volume growth and protecting the margins, the company is opting for the latter. ((Procter & Gamble Fiscal 2015 Fourth Quarter Earnings Call Transcript, Seeking Alpha, July 30, 2015) This is because P&G is currently moving around a number of structural pieces – changes which are meant to put it in an optimal position once the pieces are in place and the global economy picks up. Until such structural changes are fully executed, the company is likely to put volume and market share growth lower on its list of priorities.

Further, unusually strong currency headwinds forced P&G to raise prices in all four quarters of fiscal 2015, with the heaviest price hikes implemented in the fourth quarter. We believe that the sustained increase in prices over an extended duration may be resulting in a snowballing effect, which dragged down the company’s volumes heavily. This is evident in the fourth quarter in which P&G’s overall volumes slumped by 3% year on year. Volumes of the Fabric and Home Care division expanded by 1% in the fourth quarter, but fell in the other four divisions by 3% to 7% year on year.

We believe that sacrificing short term growth for potential long term gains is a bold but risky move, which may or may not pay off. Instead, an ideal strategy would be to give equal preference to both these components. By giving equal importance to short term revenue expansion, P&G could hedge itself against a scenario where the long term strategic changes fail to yield expected results. On the other hand, the current strategy hinges on the long term plan playing off as expected and the investors’ patience in the meantime.

No Intention to Scale Back Investments

While P&G propounds heavy emphasis on productivity improvements even at the cost of top-line growth, it does not intend to scale back on investments and reallocation of resources. For instance, the 130 basis points of benefit derived from productivity savings in the fourth quarter were reinvested back into sales coverage and the innovation pipeline. Consequently, fourth quarter non-GAAP operating margin improved by just 90 basis points despite a total benefit of 350 basis points from cost savings. ((Procter & Gamble Fiscal 2015 Fourth Quarter Earnings Call Transcript, Seeking Alpha, July 30, 2015)

P&G’s current strategy is to channel most of the savings from productivity improvements back into other focus areas like supply chain and innovation. The combination of declining revenues, minimal margin expansion, and rising investments imply that P&G’s net profit margin is likely to fall in the near term.

In summary, we believe that precarious times lie ahead for Procter & Gamble. The company has stuck to its guns on putting margin protection over volume and market share growth, even amidst spiraling competition from Unilever and Kimberly-Clark. While P&G’s focus on long term reorganization is appreciable, we believe that ignoring the short term revenue growth and margin expansion could erode shareholder value during the transitional period. This makes the success of P&G’s long term plans all the more crucial for the company as well as its investors.

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Notes:
  1. P&G Press Release, July 30, 2015 []
  2. Procter & Gamble Fiscal 2015 Fourth Quarter Earnings Call Transcript, Seeking Alpha, July 30, 2015 []