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Summary

  • Organic revenue and volume growth improving.
  • Currency volatility and Ukraine in Q1 '14 likely impacted PG.
  • Sale of Pet Foods business a plus.
  • PG's longer-term issue is to grow volume while not crushing margins..

Here is a brief look into Procter & Gamble's (NYSE:PG) fiscal q3 '14 earnings report due out Wednesday morning 4/23/14, before the market opens.

From a longer-term, 30,000 foot view, PG is in the midst of an ongoing re-organization under former, and now new CEO AG Lafley, as the post 2008 Recession beatdown of the high-end or premium consumer brands, both in the US and in the emerging markets, left PG with declining volume, revenue and EPS growth.

Possibly due to the growth of new retailers niches like Whole Foods (NASDAQ:WFM) and Costco (NASDAQ:COST), with enormously popular private-label brands like Kirkland, PG has found itself scrambling with its iconic premium-brands like Pampers and such, while still popular, being priced at substantial premium to other consumer brands.

PG is your classic consumer staple stock, with pretty consistent low to mid-single-digit organic revenue and volume growth. Roughly 40% of its revenues come from Emerging Markets, so the currency turmoil in Latin America in early '14 was a buying opportunity, and we added to the stock when PG traded down to $75 or the late 2007, multi-year high for the stock; we took the opportunity to add to the position.

As price competition heats up for PG, and the company feels pressure to grow volumes, the key issue for PG going forward (in my opinion) is how to not step all over margins and revenue growth, while still improving volume growth.

Common Size P/L
Procter & Gamble ($'s ml.)6/30/20143/31/1`412/31/20139/30/20136/30/20133/31/201312/31/20129/30/20126/30/20123/31/201212/31/20119/30/20116/30/20113/31/201112/31/20109/30/20106/30/20103/31/201012/31/2009
Net Salesn/an/a100%100%100%100%100%100%100%100%100%100%100%100%100%100%100%100%100%
Cost of products soldn/an/a50.0%51.0%52.5%50.0%49.1%49.9%51.9%50.7%50.3%49.5%51.7%49.5%48.2%48.2%50.5%48.1%46.3%
Marketing, Research & adm.n/an/a29.6%29.4%33.2%31.2%30.7%31.0%32.9%32.9%29.9%29.8%32.5%31.9%31.9%29.5%33.9%31.2%31.6%
Operating Incomen/an/a20.4%19.6%14.2%18.8%20.3%19.1%15.2%16.4%19.8%19.8%15.7%18.6%20.0%22.4%15.6%20.7%22.1%
interest expensen/an/a1%1%1%1%1%1%1%1%1%1%1%1%1%1%1%1%1%
other income (expense) netn/an/a0%0%0%0%4%0%0%0%-1%0%1%0%0%0%-1%0%0%
Pre-tax earningsn/an/a20%19%12%16%24%18%14%16%12%19%15%18%19%21%14%20%21%
income taxesn/an/a4%5%3%3%5%5%3%4%4%5%3%4%3%6%2%6%6%
Net Incomen/an/a16%14%11%15%18%14%11%12%8%14%12%14%16%15%12%13%15%
Growth rates
Procter & Gamble ($'s ml.)6/30/20143/31/1`412/31/20139/30/20136/30/20133/31/201312/31/20129/30/20126/30/20123/31/201212/31/20119/30/20116/30/20113/31/201112/31/20109/30/20106/30/20103/31/201012/31/2009
Net Sales5%3%0%-7%7%3%0%-9%1%5%3%-5%6%6%-1%-9%6%
annual growth rate1%1%0%2%2%2%0%-5%-3%0%4%9%10%5%2%2%1%4%3%
Cost of products soldn/an/a3%0%5%-5%5%-1%3%-8%2%1%8%-3%6%1%4%-5%4%
annualizedn/an/a2%4%3%1%-2%-5%-3%2%8%12%13%8%6%3%3%1%-1%
Marketing, Research & adm.n/an/a6%-9%7%-5%6%-3%0%0%2%-4%5%-5%15%-8%7%-10%11%
annualizedn/an/a-3%-3%3%-3%3%-1%-2%3%-3%10%6%8%2%0%10%8%6%
n/an/a
Operating Incomen/an/a10%41%-24%-14%14%29%-8%-24%1%32%-13%-11%-5%53%-26%-15%5%
yoy growthn/an/a1%5%-4%17%3%-9%-7%-12%3%-4%11%-5%-8%1%-17%6%10%
interest expensen/an/a
other income (expense) netn/an/a
n/an/a
Pre-tax earningsn/an/a10%60%-24%-37%36%32%-9%18%-34%28%-12%-10%-5%64%-30%-16%7%
yoy growthn/an/a-15%5%-14%3%93%-7%-9%-12%-33%-4%22%-3%-9%2%-20%8%12%
income taxesn/an/a
Net Incomen/an/a14%32%-24%-25%43%29%-9%44%-44%20%-13%-14%8%41%-15%-18%4%
yoy growthn/an/a-15%7%5%26%141%-6%-12%-15%-49%-2%15%11%6%2%-12%0%6%
shares outstanding - diluted (y/y)n/an/a0%4%0%0%-1%-4%-2%-2%-2%-3%-3%-3%-4%-3%-1%0%-2%
Earnings per sharen/an/a15%33%-20%-19%15%29%-13%-15%7%23%-13%-14%9%44%-20%-19%4%
yoy growth18%3%-1%-1%-4%5%11%3%-2%-2%-1%1%18%8%1%-4%-14%6%13%

The above spreadsheet, which shows the y/y growth rates for revenues and EPS for 3/31/14 and 6/30/14 based on the consensus estimate, also gives a decent look at the trends in margins, and the y/y growth rates of historical data.

Like a lot of Consumer Staples stocks, PG can sustain low to mid-single-digit revenue growth if they can manage the cost centers or the marketing, R&D and other expense growth, without cutting bone.

Ultimately, I would think the company would prefer top-line growth, and a return to normalcy and growth in the Emerging Markets.

For patient investors, I think PG is the best play on the emerging middle-class in the Emerging Markets, but they need to get the pricing right.

As we await 4/23/14's earnings, the strengths of PG are the following:

1) Management is working to remedy or massage the trilogy of volume, pricing and mix to sustain longer-term growth for all three, but not sacrifice long-term margins;

2) PG's cash-flow and balance sheet is rock-solid, with a high investment-grade credit rating. Spinning off the Pet Foods business seems like a plus.

3) 4-quarter trailing free-cash-flow (FCF) has stagnated around $9 - $10 per quarter, down from the $13 billion in 2009 and 2010, and PG is returning over 100% of FCF to shareholders without adding long-term debt so while this is a strength right now, this could also be a weakness down the road;

4) PG's dividend yield is right around 3% and the dividend is about 2/3rd's of total free-cash-flow.

Weaknesses:

1) PG's premium brand pricing has become more of an issue since the 2008 Recession. I read an analyst report a couple of years ago (can't recall the source) that said that PG was priced at a 35% - 40% premium to its closest competitors in many of its key products. No question that is an issue;

2) PG's growth has slowed considerably in the last few years.

To conclude, we continue to hold PG's stock in client accounts and to add to the position on substantial pullbacks. PG needs some consistent growth through mid-single-digits and higher preferably in organic volumes and revenues, without sacrificing margins.

Our internal earnings model values PG in the mid $90's while Morningstar assigns a perceived intrinsic value to PG of mid $80's.

PG is modestly undervalued at current prices, and the market is rewarding slow, stable, consistent dividend growers this year, versus 2013.

Source: Procter & Gamble Earnings Preview: Classic Defensive Staples Stock