Procter & Gamble’s Q2 Organic Sales Growth Returns to Positive Territory on Pricing; Profits Jump on Productivity Improvements

Procter & Gamble (NYSE:PG) returned to positive organic sales growth territory in fiscal 2016 second quarter results released on January 26th. ^[1] The company managed to achieve this feat through a sharp surge in pricing across the board, even as volumes fell in business divisions. P&G reiterated its policy of disregarding volume growth and market share gains in the short term to preserve its bottom-line and “value creation”. ^[2] The comparators are likely to get softer two to three quarters down the line, but until then, we believe that Procter & Gamble is unlikely to return to meaningful volume growth. Nevertheless, the company continued the trend of achieving solid margin improvement through productivity savings in the fourth quarter, which remains the only silver lining in the near to medium term.

Procter & Gamble’s fiscal 2016 second quarter performance snapshot:

• Net sales as reported declined by 9% year on year to $16.9 billion. On a constant currency basis, they increased 2%.
• Non-GAAP gross margin improved by 210 basis points to 48.7%
• Non-GAAP operating margin improved by 350 basis points to 23.5%
• Non-GAAP EPS improved by 9% year on year to $1.04

Our price estimate of $76 for Procter & Gamble is slightly lower than its current market price.

See our complete analysis for Procter & Gamble here

Is the Return to Organic Sales Growth Meaningful?

After a tough first quarter, when Procter & Gamble’s organic sales growth turned negative, investors may have been relieved at first glance when the company bucked the trend in the second quarter. However, the achievement is not a fundamental change in the company’s fortunes but more of a temporary reprieve.

Source: Procter & Gamble Investor Relations

As seen above, Procter & Gamble implemented heavy price hikes in all its business divisions in an effort to counter the soaring currency headwinds. To be fair, some portion of these price hikes may be a result of premium innovations introduced in existing products, which the company had been working towards since last year. But P&G itself admitted that it has not been “as agile as it needs to be” in leveraging the premiumization drive in major markets like China. ^[2]

Either way, the downside to such sustained increase in prices is the clearly plunging volumes. Procter & Gamble has repeatedly stated that it is willing to lose volumes and market share in the short term in favor of margins and “value creation”. ^[2] We believe this to be a reasonable temporary strategy, but P&G may be taking it too far by allowing volumes to slump two quarters in a row. This takes on even more importance in light of the volume gains achieved by smaller rivals, Unilever (NYSE: UL) and Kimberly-Clark (NYSE:KMB).

Even worse, P&G plans to keep relying on pricing in the short term, which could put further pressure on its volumes. ^[2] We do not expect the company’s volume growth and market shares to stabilize until fiscal 2017, when the comparators will begin to soften and P&G’s brand consolidation program will be fully completed.

Margin Accretion Continues on Productivity Improvements

P&G’s recent strong track record in margin expansion continued in the second quarter. Productivity savings and overhead cost reductions helped improve the non-GAAP operating margin by a massive 350 basis points year on year, to 23.5%. This trend is likely to continue in the near to medium term, although the benefits from the productivity improvements may not fully trickle down to the bottom-line.

In the second quarter, marketing expenditure as a percentage of sales was at the same level as in the year ago period. This figure is likely to increase year on year in the coming quarter as P&G plans to increase its investment in marketing. Therefore, while the margin accretion is likely to continue in the near term, it may not be at the same level as the massive gains in the second quarter.

Further reading:

• Innovation May Well Have Driven P&G’s Organic Growth Back to Positive Territory in Q2
• Here’s Why Procter & Gamble Should Not Break Up
• Kimberly-Clark’s Moderate Organic Growth Wiped Out by Currency Headwinds in Q4
• Unilever 2015Q4 Earnings: Premium Products and Spreads Business in Focus

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More Trefis Research

1. Procter & Gamble Investor Relations [↩]
2. Procter & Gamble Fiscal 2016 Second Quarter Earnings Call Transcript, Seeking Alpha, January 28, 2016 [↩] [↩] [↩] [↩]