Procter & Gamble (NYSE:PG) opened its books for the third quarter last week. Investors were relieved by the earnings report which broadly came in line with expectations.
While short term headwinds continue to put pressure on the reported results, investors are overlooking these headwinds by focusing on better days ahead. Despite the prospects for further growth, the valuation is already quite steep. However, the company remains a top-quality business generating solid returns for its shareholders through dividends and repurchases.
Third Quarter Headlines
Procter & Gamble reported revenues of $20.56 billion which was down by 0.2% compared to last year. What should be noted is that adverse currency effects shaved off three percentage points of reported revenues.
Net earnings attributable to shareholders rose by 1.7% to $2.61 billion with diluted earnings per share increasing by two pennies to $0.90 per share.
Looking Into The Numbers
Headline revenue growth as reported was disappointing driven by the depreciation of major emerging currencies against the US dollar. As a matter of fact, the company reported a $0.10 per share charge related to the depreciation of the Venezuelan currency.
Organic sales were solid showing 3% annual growth, driven by a 3% increase in volumes. Sales were notably strong in the fabric care and home care business which reported 6% sales growth, offset by slower growth in the beauty, grooming and baby, feminine and family care businesses. The health care business saw its revenues stagnate, coming in unchanged compared to last year.
Gross margins fell by 135 basis points to 48.3% of total revenues. Margin pressure was more than offset by strong cost cutting efforts. Selling, general and administrative expenses fell by 175 basis points to 31.6% of sales, sparking a modest gain in operating margins despite the currency-related charges.
While reported GAAP earnings rose just by two pennies, the so-called core earnings rose by 5 pennies to $1.04 per share. Adjusting for the negative impacts of currency movements and core earnings would have risen by 17% compared to last year.
Procter & Gamble continues to focus on the return of capital to its shareholders, which have seen a long term underperformance, while focusing on future growth and improved profitability.
The company spent $1.5 billion on share repurchases during the quarter while hiking its dividend to $0.6436 per quarter. This provides investors with a 2.7% repurchase yield and a 3.2% dividend yield. Combined, investors can expect payouts which approach 6% of the market capitalization per annum.
These payouts come at a price. While the company holds $8.2 billion in cash and equivalents, Procter also holds roughly $36.7 billion in debt which results in a sizable net debt position of $28.5 billion.
Given the results so far this year, Procter is on track to generate revenues of $85 billion while reporting earnings of $11-$11.5 billion
Pet Care Divestiture
Earlier this month Procter & Gamble already announced the divestment of a huge portion of its Pet Care business. Mars will acquire the Iams, Eukanuba and Natura brands which make up 80% of total Pet Care sales.
Procter receives $2.9 billion in cash for the sold activities which are located in the health care business of Procter and Gamble. With the deal, the company can streamline its operations and focus on the company's core competencies.
Implications For Investors
Procter & Gamble is by no means cheap at current levels. The current $81 price level results in a $220 billion valuation, the equivalent of 2.6 times annual revenues and 19-20 time earnings.
Of course topline growth is limited as a result of currency depreciation, the sale of non-core businesses and the time it takes for CEO Langley to reignite innovation. To boost the bottom line in the short term, Langley focused on cost cutting, aiming to save $10 billion in costs through 2016.
The combination of this could boost earnings to $13-$14 billion in 2016 which would make the price-earnings multiple a lot more acceptable. While this obviously takes time, Langley resorted to high payouts through acquisitions and dividends in order to please investors in the meantime.
Investors in Procter & Gamble are positioned to benefit from earnings improvements going forwards although a lot of these improvements have already been priced into the shares at current levels. For dividend-oriented investors a long term investment which is acquired on dips might represent excellent entry points.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.