Shares of Procter & Gamble (PG) hardly moved after the provider of premium consumer package goods released a first quarter earnings report which did not include many surprises.
Investors who belief in Lafley's long term value creating strategy, continue to have the opportunity to pick up a quality name at a discount to its major peers. While the dividend and share repurchases offer immediate cash flows to investors, the absolute valuation remains a bit rich.
First Quarter Results
Procter & Gamble generated first quarter revenues of $21.20 billion, up 2.2% on the year before, and slightly ahead of consensus estimates at $21.1 billion.
Net earnings rose by 7.2% to $3.06 billion in the meantime. Diluted earnings per share rose by 8 percent to $1.04 per share, while core earnings came in a penny higher. Core earnings were in line with consensus estimates.
CEO and Chairman Lafley commented on the first quarter performance, "We have good market share momentum, a number of strong innovations coming to market over the balance of the year, and cost savings from productivity efforts that will continue to build. We remain focused on driving innovation and productivity. We continue to improve operating discipline and execution every day to create value for consumers and shareowners."
Looking Into The Results
Reported revenues understate the true extent of Procter & Gamble's progress. Organic sales grew by some 4 percent, as adverse currency headwinds shaved of 2% in revenues. Note that prices and the product mix didn't have any impact on the bottom line.
Volume growth was driven by Fabric Care and Home Care, as well as the Baby, Feminine and Family Care business, each reporting sales growth of 6%. Growth in the home care business was driven by the distribution of Duracell batteries. The baby, feminine and family care business saw strong growth thanks to product innovation and growth in developing markets.
Adjusted operating margins fell by 70 basis points on the back of lower gross margins, partially offset by lower selling, general & administrative expenses.
Core earnings came in at $1.05 per share, as foreign currencies shaved off $0.09 per share in earnings. Reported operating margins rose by 50 basis points on higher revenues and lower restructuring spending, despite pressure on gross margins.
Gross margins were under pressure on commodity costs and manufacturing start-up costs. This was offset by manufacturing savings elsewhere, and a reduction in selling, general & administrative costs.
Procter & Gamble reiterated its full year guidance, seeing organic sales growth of 3-4%. Sales growth is seen up between 1 and 2%, including anticipated currency headwinds of around 2%.
Core earnings per share are seen up by 5-7%, as reported earnings per share are seen up by 7 to 9% for the coming year.
Growth is expected to accelerate into the second half of the year on the back of top line growth, productivity savings and easier foreign exchange comparables.
Procter & Gamble ended its first quarter with $7.7 billion in cash, equivalents and for-sale investment securities. The company operates with $34.8 billion in total debt, for a sizable net debt position of around $27 billion.
Revenues for Procter's fiscal 2013 came in at $84.2 billion, up 0.6% on the year before. Net earnings rose by 5.2% to $11.3 billion.
Factoring in losses of 1% in pre-market trading, the market values the company at $219 billion. This values equity in the firm at 2.6 times annual revenues and 19-20 times annual earnings.
Procter & Gamble currently pays a quarterly dividend of $0.6015 per share, for an annual dividend yield of 3.0%.
Some Historical Perspective
Long term holders have seen very fair returns. Shares rose from $50 in 2004 to highs of $75 in 2007. Shares fell back towards $45 in 2009 amidst the financial crisis to gradually recover to all time highs around $80 per share at the moment.
Between 2010 and 2013, the company has grown its annual revenues by a cumulative 8-9% to $84.2 billion. Earnings fell by some 11% to $11.3 billion over the same time period. The earnings fall was partially offset by share repurchases after Procter retired some 5% of its shares outstanding over this time period.
It is still early n Procter & Gamble's long term restructuring efforts. Back in May it brought back long-standing CEO Lafley, which engineered the multi-billion deal to acquire Gilette, but also pushed hard for internal product innovation. Lafley was pushed forward by hedge fund Bill Ackman which bought a stake in PG last year, and actively tried to push out former executive McDonald.
During the end stage of his tenure, McDonald implemented a strategy to focus on the US and unveiled a $10 billion cost cutting program, with the first benefits now being seen by shareholders. The difficult stage of the new strategy, being organic growth and product innovation still have to show even as the company reported a 4% growth in organic sales. This more difficult stage is to be engineered by Lafley which will furthermore expand the line-up of lower priced products.
At the moment, Procter & Gamble is operating in a tough environment with private-labels outcompeting some of Procter's premium products. In some sense, Procter & Gamble is too-diversified, resulting in a lack of focus, thereby allowing underperforming assets to be put a drag on the valuation.
Competitors are noting that Procter is stepping up. Unilever's CEO Paul Polman noted that the company unleashed an "enormous competitive attack" in key categories such as deodorant.
According to analysts, these are the main reasons why shares trade at a discount to some of its global peers, although a valuation of around 20 times earnings is already quite steep.
Just a few weeks ago, I last took a look at Procter & Gamble's prospects after Wells Fargo raised the price target for the firm to $86 per share.
I concluded that long term prospects emerge after the business has stabilized. Investors where happy with Lafley's return, given his history for making bold moves. The poor premium position during the recession and expensive international expansion could all come to an end, thereby boosting value for shareholders.
While Lafley still sees 2014 as a transition year, core earnings are still seen up by 5-7%, driven by solid organic sales growth of 3-4%. At the time, I envisioned $90 billion in sales being possible for 2015, as earnings could increase towards $13.5 billion, resulting in a price-earnings ratio of around 15. Continued dividends of $6 billion per annum, and a similar budget for share repurchases, provide investors with a nice combined yield of around 6%.
I reiterate my stance. I remain cautiously optimistic in the long term for this high-quality dividend paying name. Yet I refrain from investing given the relative high absolute valuation of the company. This is even as the relative valuation and the combination of dividends and share repurchases look attractive.