P&G’s (PG) earnings report was well received by the market last week. Currency-neutral earnings per share grew 12%, margins expanded nicely, and management’s expectations for improving organic sales growth trends were reaffirmed.
After analyzing the report, we are happy to keep P&G in our Conservative Retirees dividend portfolio. However, many investors remain concerned about underlying volume trends across each of P&G’s segments.
Organic sales declined by 1% last quarter, driven by favorable price/mix benefits of 3% and a volume decline of 4%. Volume declines were seen across every segment: Beauty -4%, Grooming -3%, Health Care -6%, Fabric Care & Home Care -2%, and Baby / Feminine / Family Care -6%.
The primary fear is that organic sales growth built on price increases alone is unsustainable. While we agree with this idea, we do not think P&G’s true volume growth was as weak as the numbers suggested. We also believe that investors need to maintain a long-term view with where the company’s transformational efforts have the business headed over the next five years, not the next quarter. These are substantial initiatives that will not pay off overnight.
Starting with the quarter, P&G’s organic sales fell by 1%. During its conference call, the company estimated that its intentional efforts to exit less profitable product categories and SKUs attributed about 1% of the total sales growth decline. Another 1% came from inventory level adjustments and capacity constraints within US Baby Care. These non-core factors could explain some of the drop in sales volume and suggest true organic sales might have actually grown during the quarter. Still, there are many moving pieces at P&G right now, and it sounds like the company is only about halfway through reviewing its remaining product portfolio for less profitable areas to step away from.
Perhaps most importantly, P&G said it expects organic top line growth to resume in Q2, with further strengthening in the back half of its new fiscal year. While it’s a very short window, management even said that October organic sales growth was 3% so far and expects the price-volume gap to narrow as the next fiscal year progresses.
P&G is digesting a lot of change right now. When the dust settles, it will have exited 60% of its brands while retaining 94% of its pretax profit by the end of September 2016. Many are griping about lackluster volume growth, but few are analyzing why those trends have occurred in the first place. While P&G’s massive size, excessive number of brands, and lack of focus have almost certainly played a role, we think the rise of private label products and consumers’ changing preferences have contributed even more.
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