Investors in Procter & Gamble (PG) are applauding a solid set of second quarter results, while the company remains upbeat about its future prospects under its transformation led by returning CEO Lafley.
Long-term appeal remains with growth prospects returning in this high-quality name which pays out fair "yields" to its shareholders. Even in 2014, the "transition" year called by Lafley, the company is making progress in both topline growth and earnings improvements.
The strong 6% yield which investors receive through repurchases and dividends are appealing, while the strong emerging market exposure offers continued growth prospects.
Second Quarter Highlights
Procter & Gamble reported second quarter revenues of $22.28 billion, up 0.5% on the year before. Revenues slightly missed consensus estimates, which stood at $22.34 billion. While report growth does not look very strong, note that the company did experience significant currency headwinds.
This very modest revenue growth resulted in a 1.3% increase in operating earnings, totaling $4.55 billion. As the company didn't benefit from one-time gains, like it did last year, net earnings fell by 14.8% to $3.47 billion. So don't read too much in these headlines, as operating earnings are solid.
Reported earnings per share fell 15% to $1.18 per share. The fall was entirely the result of a gain last year related to the purchase of the Baby Care and Feminine Care joint venture.
Core earnings came in at $1.21 per share, down a percent on the year before, but a penny ahead of consensus estimates. Adjusted for currencies, core earnings rose by 8%. These results are quite solid, and show the progress which the company is making in this "transition" year.
Looking Into The Numbers
Reported headline revenue numbers showed not much growth, but the company stresses that it witnessed a 3 percentage points adverse impact from currency movements. Notably, the depreciation of the Japanese and Venezuelan currencies hurt.
This was offset by 3% organic growth, which was driven by 3% volume growth as pricing and the mix balanced each other out.
Developed markets showed little growth, but the 8% organic growth rates in emerging markets are very solid and are applauded by the investment community. Volume growth occurred in all five major divisions of the business. Health care reported 6% volume growth, fabric care 5%, and baby, feminine and family care revenues were up by 3%.
Gross margins were under pressure, falling 90 basis points to 50.0% of total revenues. While the company managed to find manufacturing efficiencies, the mix hurt gross margins. Developing markets carry lower gross margins, while beauty product sales which carry higher margins were disappointing.
Fortunately the company made progress in tackling operational costs, cutting selling, general & administrative costs by 100 basis points to 29.6% of total revenues. This combined resulted in a 10 basis point improvement in operating earnings to 20.4%.
Procter remains confident in the remainder of 2014, noting that the second half should be stronger. Organic sales, after adjusting for currency movements and the net impact of acquisitions as well as divestitures, should increase by 3%-4%. This should allow core earnings to grow between 5% and 7%.
Investors Are Buying It
On the back of the results, investors sent shares 3% higher to levels in their low eighties, valuing the business at $220 billion.
Returning CEO Lafley sees increasing household incomes in developing markets as a significant driver for growth, overcoming domestic weakness in the company's goal to regain market share.
Lafley follows up on former CEO McDonald's cost-saving program. Procter aims to save a cumulative $10 billion in costs of goods sold through 2016, with savings totaling $1.2 billion in the past year. This, combined with innovation, should be a driver of both revenue growth and earnings growth. As stated by Barclays analyst Lauren Lieberman, Procter's innovation in recent years has focused on "bundling" of benefits rather than breakthroughs such as the "Swiffer". Lafley has stated before, that innovation is a top priority alongside with cost cuts when he returned.
In the meantime, shareholders are being well-looked after. The quarterly dividend of $0.6015 per share provides investors with a 3.0% dividend yield. On top of this come $5 to $7 billion in annual share repurchases, which essentially means that the company is targeting nearly 100% of earnings to be "returned" to shareholders.
These high cash flows to investors result in some leverage on the balance sheet. While the company holds nearly $7 billion in cash and equivalents, the total debt pile stands at nearly $36 billion, for a net debt position of $29 billion.
Remain Cautiously Optimistic
Back in October, I checked out the prospects for Procter & Gamble when it released first quarter results which didn't contain any large surprises.
I noted that Lafley sees 2014 as a transition year, but if topline growth reignites in 2015, sales of $90 billion might be possible. With the effect of cost savings becoming more pronounced, earnings could increase towards $13-$14 billion, resulting in a price-earnings ratio of 16. In the meantime, investors stand to receive a very nice "yield" of 6% through repurchases and dividends.
The long-term prospects, driven by emerging markets might be favorable. The quality long-term track record and high payout to investors make the stock continue to have appeal in the long term, making it an excellent holding in any long-term well-diversified portfolio.