Investing Club: Procter & Gamble's pricing power leads to beats on the top and bottom lines

Published Wed, Apr 20 202212:14 PM EDTUpdated Wed, Apr 20 202212:19 PM EDT

Recent Club addition Procter & Gamble (PG) on Wednesday reported quarterly earnings and sales that beat Wall Street's expectations, as the consumer goods powerhouse was able to pass along higher prices to offset the impacts of rising inflation. The company reported net sales of $19.38 billion, a gain of 10% over last year and well above the $18.73 billion expected by analysts. Earnings per share were $1.33 adjusted, compared to the $1.29 sought by the Street. Bottom line Procter & Gamble's pricing power was on full display as superior product offerings and continued innovation clearly resulted in customer loyalty. By investing in innovation, P & G is able to more effectively market its products and pass through higher commodity and shipping costs. Customers may pay more at checkout, but they believe it's justified as more-efficient products stretch for a longer periods of use. Asked on the earnings call about demand elasticity and the potential that consumers are about to become much more price sensitive and "trade down" to cheaper alternatives, management noted that elasticities have been better by about 20 to 30% versus historical figures. In management's view, superiority is the best protection P & G has against consumers trading down. In fact management said it has seen continued "trade-in and continued trade-up" to pricier items. An example of this can be seen in the formula innovation on Tide and Laundry detergent (discussed below). The Covid lockdowns in China and the ongoing Russian invasion of Ukraine are headwinds. P & G has two factories in the Shanghai area, making the country both a supply and demand challenge. But management believes the current headwinds are temporary and continues to view the market as "very attractive." The Russia-Ukraine conflict, meanwhile, is estimated to have negatively impacted earnings by about a penny per share. Consolidated results While Procter & Gamble was able to demonstrate strong pricing power, it did have to eat some costs as gross margin fell 400 basis points year-over-year, more than the 200 basis points drop the Street expected. Driving the contraction was higher commodity prices, freight costs, product and package reinvestment. That negative impact was partially offset by higher prices for consumer and improved operating efficiency. Those higher input costs were further balanced by reducing selling, general and administrative expenses as a percentage of revenue. Operating cash flow of $3.2 billion came up short versus the $4.856 billion consensus while adjusted free cash flow productivity, defined as "the ratio of adjusted free cash flow to net earnings" came in at 74% for the quarter as strong sales led to an increase in receivables and inventory. Lastly, management returned a total of $3.4 billion in cash to shareholders with $2.2 billion coming in the form of dividends and the other $1.2 billion via share repurchases. As a reminder, management also announced a 5% increase to the dividend last week, the 66 th consecutive annual increase. Segment Results Beauty sales of $3.39 billion, up 3% over last year, outpaced the $3.35 billion consensus Skin and personal care segment had low single digit organic sales increase on the back of higher pricing and market growth Hair care sales increased in the low single digits organically as higher pricing was partially offset by pandemic-related volume slowdowns. Grooming sales of $1.48 billion, an increase of 8% year-over-year, exceeded expectations of $1.47 billion, with all geographic regions seeing organic growth. Shave care was a strong performer with organic sales growing double digits thanks to innovation, market growth, higher pricing, and a positive mix of premium products and developed products. Appliances saw a single digit organic sales decrease as the prior year's period was bolstered by higher consumption of in-home shavers and stylers during the pandemic. Health care sales of $2.66 billion, an increase of 16% over the prior year, were better than the $2.5 billion consensus, with all regions seeing organic growth in the quarter. The segment benefited from a high single digit organic increase in oral care products thanks to growth in premium products and pricing power. A greater than 30% organic increase in personal health care on the back of a stronger cough, colds and flu season versus the year ago period. Fabric and home care sales of $6.7 billion, up 10%, outpaced expectations of $6.44 billion. Fabric care sales were up double digits organically thanks to premium products, innovation and pricing power. On the call, management shared an example of how innovation is leading to higher prices for P & G while saving consumers money. Advancements made in Tide and laundry detergent to improve performance in cold washing mean consumers may have to pay up a bit for product, but they save on the back end thanks to not having to heat up the water. Given higher energy prices, that's a meaningful benefit. Home care posted a mid-single digit increase in organic sales thanks to higher prices. The segment lapped a difficult comparison period due to an increase in pandemic-related consumption of cleaning products. Baby, feminine and family care sales of $4.94 billion, up 10%, exceeded the $4.76 billion consensus with all regions seeing organic growth in the quarter. Baby care sales increased double digits organically thanks to innovation, market growth, pricing power. Feminine care organic sales were also up double digits benefiting from innovation, market growth, pricing power, and a positive mix shift. Guidance Looking ahead, management called out an expectation for the labor market to remain tight, freight and commodity cost inflation — calling out "little sign of near-term relief" — and another step up in foreign exchange headwinds. Note the incredible strength we have seen in the dollar. Combined these headwinds are likely to negatively impact full-year fiscal earnings by $1.26 per share, a 22% headwind to core earnings. But thanks to innovation and product superiority resulting in pricing power, management was able to raise their fiscal-year 2022 organic sales growth guidance to the 6% to 7% range, up from 4% to 5% previously. On the call, the team commented that "pricing was a sequentially stronger contributor to top line growth in the third quarter and will continue to be a driver again in the fourth quarter as we get the full impact of increases taken over the last few months." Additionally, management now expects earnings growth to come in at the lower end of 3-6% range previously provided. The Street was modeling 3.3% into the print. In addition to the headwinds noted above that are impacting all companies, management expects the Russia-Ukraine conflict to result in a negative $0.04 earnings per share impact in their fiscal fourth quarter. In terms of shareholder capital returns, the team expects adjusted free cash flow productivity of 95% to pay over $8 billion in dividends and repurchase $10 billion of common shares in the fiscal year amounting to a total cash return to shareholders of over $18 billion. (Jim Cramer's Charitable Trust is long PG. See here for a full list of the stocks.) 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Tide by Procter & Gamble on sale at a Ralphs grocery store in Pasadena, California.

Mario Anzuoni | Reuters

The company reported net sales of $19.38 billion, a gain of 10% over last year and well above the $18.73 billion expected by analysts. Earnings per share were $1.33 adjusted, compared to the $1.29 sought by the Street.