Cost Savings Will Support P&G’s Gross Margins Amid Timid Sales Outlook

Procter & Gamble (NYSE:PG) is slated to release its earnings results for the first quarter of FY 2014 on Friday, October 25. The world’s leading consumer goods company posted 3% organic sales growth in FY 2013 as volumes increased 2% and pricing added 1%. The performance was broad-based as all the divisions delivered year-on-year organic sales growth. Despite a healthy increase in organic sales, P&G’s net sales increased by only 1% due to unfavorable foreign exchange rates. ^[1]

P&G is increasing its focus on developing economies in order to tap high growth opportunities. The company registered organic sales growth of 8% in its top 10 developing markets in FY 2013. However, many of these markets have become victims of currency devaluation, which is taking a toll on consumer demand in addition to creating negative exchange rate impacts.

Last month, rival Unilever (NYSE:UL) announced that it is expecting lower underlying sales growth (sales growth from continuing operations excluding acquisitions, disposals and currency movements) in the third quarter of 2013 compared to the first half of the year due to the sluggish growth in emerging markets. ^[2] We expect P&G to face similar headwinds in its Q1 FY 2014 results.

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Emerging Market Slowdown To Impact Sales Growth

P&G’s products usually sell at higher price points due to their premium quality. The demand for such products is greater in the developed economies than the emerging ones since the former have higher purchasing power. The company derives less than 40% of its revenues from emerging markets. It is looking to further enhance its presence in these markets as they continue to grow at much faster rates than developed economies. In P&G’s last earnings call, the management identified developing markets as a big opportunity for the company. ^[3]

Lately, many emerging markets have been plagued with currency weaknesses. Year to date, the South African Rand (ZAR) has depreciated 18% relative to the EUR, while the Indian Rupee (INR) and the Brazilian Real (BRL) have depreciated by 13% and 10% respectively. ^[4] This rapid currency depreciation has created inflationary pressures on buyers who have reduced consumption.

Since the emerging markets are gaining priority for P&G and contribute substantially to total company sales, we expect the company to register organic sales growth at the lower end of its 3%-4% guidance. A prolonged slowdown would be more detrimental for P&G as it could hamper the company’s expansion plans, and consequently its growth trajectory.

Cost Savings And Productivity Enhancement Initiatives To Support Gross Margins

P&G announced a restructuring program in 2012 through which it aimed to save $10 billion in costs. Under this program, the company will save $6 billion in costs of goods sold while another $1 billion and $3 billion from marketing efficiencies and non-manufacturing overhead, respectively. The company is also working to reduce its working capital requirements by as much as $2 billion by increasing the number of days it takes to pay its suppliers. The full program is expected to complete by the end of FY 2016.

The agenda behind the cost savings and productivity enhancement initiatives is to have financial flexibility in order to maintain investment levels and drive long term growth even in weaker microenvironments. P&G delivered better than its plans for fiscal year 2013, with a 7% increase in manufacturing productivity compared to the targeted 5%. The initiatives helped P&G offset the impact of innovation related and new production capacity startup costs on its gross margins, which increased 30 basis points in FY 2013. ^[1] We believe these initiatives will continue to benefit the company.

We will update our $74 estimate for Procter & Gamble based on the upcoming quarterly results.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Procter & Gamble Q4 FY 2013 Results, P&G Investor Relations, August 1, 2013 [↩] [↩]
2. Unilever on track to meet its 2013 priorities despite slower market growth in many emerging countries, Unilever Press Release, September 2013 [↩]
3. Procter & Gamble’s CEO Discusses F4Q 2013 Results – Earnings Call Transcript, Seeking Alpha, August 1, 2013 [↩]
4. www.oanda.com [↩]