P&G Rewards Longs With Better Sales And Stronger Margins

By Stephen D. Simpson, CFA | January 27, 2013 AAA

Although I recently suggested that Wall Street has already amply rewarded Procter & Gamble (NYSE:PG) for its self-improvement potential, the company showed in its fiscal second quarter results that it may still have more on the table. While incrementally less momentum in developing economies could eventually develop into another problem to address, P&G management is simultaneously delivering on product innovation/introduction and cost cutting.

SEE: A Guide To Investing In Consumer Staples

Good Results from the Top on Down
P&G posted a good, solid beat for its fiscal second quarter. Revenue rose 2% as reported, but increased 3% on an organic basis (about 1% higher than expected), with even progress in both volume and price. Good results in developed markets are counterbalancing slowing growth in developing markets.

Growth was relatively consistent across product lines, even if the make-up of that growth was not. Grooming saw 2% organic growth (on zero volume growth), while beauty and fabric/home care were both up 3% (on zero and 2% volume growth, respectively). Health care was up 4% (on 3% volume growth), while baby/family care revenue rose 5% on 6% growth in volume.

Cost-cutting and margin improvement are key to the P&G story now, and management continues to deliver good results. Core gross margin improved more than a point, while core/adjusted operating income rose 7% (with no incremental operating margin improvement net of the gross margin improvement). Here, too, the categories were across the board - beauty, fabric/home and baby/family all posted low-to-mid teens segment profit growth, while grooming was flat and health care was down in the mid-to-high single digits.

Although below-the-line items did boost P&G's reported results, the company still posted a clean beat of five or six cents on better sales and margins.

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Relative Performance Seems to Put P&G in the Middle
While better-than-expected performance is almost always a positive, it's also true that doing a little bit better means less if your peers are all doing a lot better. To that end, Procter & Gamble's performance seems to fit in the middle of the pack.

Unilever (NYSE:UL) saw nearly 8% organic growth, with nearly 5% growth in volume. Kimberly-Clark (NYSE:KMB) was also quite strong with 5% organic growth for its December quarter. On the other hand, Helen Of Troy (Nasdaq:HELE) saw a revenue decline in its personal care segment for the quarter that ended November 30. Johnson & Johnson (NYSE:JNJ) saw just 1% operational growth in its consumer segment, with categories like baby care (up 3%) and oral care (up 2%) showing comparable-to-lower performance relative to P&G.

All in all, however, I'm not too worried about where P&G sits in the industry. The company's portfolio tends to skew toward the higher end of the price range, which may explain why the company saw year-on-year share loss but improving sequential results. In other words, I think consumers are starting to feel a little better about their budgets/economic situations and tentatively going back up market - at least on selective items.

SEE: 5 Must-Have Metrics For Value Investors

The Bottom Line
The next couple of quarters will be important for Procter & Gamble on at least two levels. The Street will want more proof that the cost/margin improvements are real and sustainable. More importantly, the company also has several product launches coming up, and seeing good acceptance/sales of these products will definitely help sentiment and bulwark the near-term revenue outlook.

With P&G's modest outperformance, I'm modestly taking my numbers/estimates a little higher. Ultimately, however, not a lot changes. While I believe P&G can grow revenue at a mid-single-digit rate and grow cash flow at a high-single-digit rate, a fair value in the low $70s still doesn't suggest any real undervaluation in these shares today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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