Procter & Gamble's (NYSE:PG) near term outlook is uncertain. Sector peer Unilever recently reported an unexpected volume decline as its growth slowed from 5% to 3%. This followed a softening of demand in recent months, with Unilever (NYSE:UL) seeing demand for its products decline further in its most recent quarter.
Since the two companies share a lot of the same product categories and there is crossover in their geographies, this is a concern for P&G. Further, the potential for a rising US interest rate could cause a negative currency impact on P&G's earnings due to 56% of its sales being derived from outside of North America.
However, I feel that its mix of cost cutting, brand reorganization, emerging market growth opportunities, as well as marketing and innovation potential will positively catalyze P&G's earnings and share price.
P&G's softening sales growth over the last couple of years has been met with success in reducing its cost base. The company has become increasingly efficient since launching a productivity program in 2012. In fact, it has beaten its goal of reducing $1.2 billion in cost of goods sold expenses per annum, reaching a figure of$1.4 billion per annum. Looking ahead, P&G is aiming to reduce costs by up to$2 billion per annum over the next five financial years. If this is achieved, it should be able to offset potential weakness in end markets.
In my view, P&G's cost reduction targets are ambitious. That's especially the case since they follow what was a successful period of cost cutting. However, with the company's major reorganization in full flow, this provides an opportunity for P&G to become leaner and more efficient which I think will be crucial in what may prove to be an increasingly competitive consumer space.
Marketing and innovation
P&G's cost cutting will provide the company with the scope to invest more capital in marketing and innovation. It will also give the company a competitive advantage over rivals, since P&G may be able to outspend them on marketing in a highly competitive marketplace. Clearly, this additional spending could take time to filter through to the company's bottom line. But I feel that investing cost savings now rather than simply paying them out in dividends or holding extra cash on the balance sheet is a sound move for the company's long term outlook.
For example, P&G recently invested in a trial program concerning its Gillette razor. This investment allowed it to gain a level of exposure among potential customers that few companies can match. And with P&G beating its target of a 90% cash flow conversion ratio, it should be able to offer further trial product programs which could boost its long term profitability.
In my view, P&G's brand reorganization will cause a degree of volatility. That's because P&G is selling off a number of brands which help to diversify the business and lower its risk profile. Brands such as Duracell have a distinct competitive advantage within their markets and P&G could miss the differentiation among its products which they offer. Therefore, I feel that P&G's earnings profile could become less stable over the medium term as it becomes increasingly reliant on a smaller number of brands.
However, P&G's disposals have been focused on the brands which it feels offer the least amount of efficiency and profitability. For example, the recent disposal of its beauty business to Coty was due to its not having the right sales/profit mix. Therefore, the remaining brands within the P&G group should offer the scope for higher margins and potentially faster growth. This could positively catalyze the company's bottom line over the medium term in my view.
P&G's non-US exposure could create challenges for the company in the short run in terms of negative currency translation. In P&G's Q4 update, it stated that currency effects negatively impacted core EPS by $0.07, reducing it from $0.86 to $0.79. In the short run, I believe that there is scope for this to worsen, since the Federal Reserve is likely to raise interest rates before the end of the year. In fact, a recent Reuters poll of economists stated that 70% of them though that rates would rise in December.
However, beyond the next few months I feel that P&G's exposure to the emerging world in particular will positively catalyze its earnings. For example, in China consumer discretionary items are forecast to grow at an annualized rate of over 7% between now and 2020. Similarly, there is opportunity in India, where GDP per capita is expected to increase by 94 % over the next four years. With P&G having increased capital available for marketing from its cost reduction program, it has the scope to spend more heavily in such markets to create greater customer loyalty and a competitive long term advantage.
P&G could experience a challenging period in the short run. Consumer goods peer Unilever reported difficult market conditions in its recent update and it would be unsurprising for P&G to experience something similar due to the product and geographical crossover between the two companies. Further, P&G's exposure to non-US markets could mean that it is hurt by additional negative currency impacts if the dollar strengthens in the short run.
However, in my view, P&G has a bright long term future. Emerging markets present high growth potential and P&G can become better positioned to take advantage of this through its innovation and marketing strategy. This will be boosted by an ambitious cost savings program, while the company's brand reorganization should also positively catalyze earnings through making the company more efficient. As such, I believe that now is the right time to buy P&G for the medium to long term.
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Disclosure: I/we 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.