Procter & Gamble gets a price target trim, but is poised for faster growth as inflation cools

Published Wed, Oct 19 20221:41 PM EDTUpdated Wed, Oct 19 20221:47 PM EDT

Procter & Gamble (PG) reported strong fiscal first-quarter earnings on Wednesday, but lowered its sales guidance as the strong U.S. dollar and inflation are forecast to remain a drag on overall results. Heading into an increasingly difficult cost environment, management maintained its forecast for earnings per share for its fiscal 2023 of flat to up 4% versus last year, warning it could be on the low end of that range. This is inline with expectations coming into the print for earnings to increase 0.3%. The consumer products giant reported net sales of $20.61 billion, a 7% organic gain over last year (versus a 5.2% estimate) and above the $20.28 billion expected. Earnings per share of $1.57 adjusted, above the consensus estimate of $1.54 per share. Bottom line We were encouraged to see that despite the difficult operating backdrop of high input costs, geopolitical issues and an increased foreign exchange headwind, Procter & Gamble was able to grow organic sales across all categories. More importantly, it maintained its global market share, accelerated productivity savings and improved supply chain efficiencies. On the earnings call with investors, management characterized this challenging period as "a rough patch to grow through, not a reason to reduce investment in the long-term health of the business." In other words, the company remains focused on the bigger picture. At the end of the day, the thing for Club members to keep in mind is this: Procter & Gamble has proven that thanks to innovation, their products have pricing power. While the full impact of that pricing isn't seen right now due to increased input costs and a material foreign exchange headwind, these costs will eventually come down. However, while the input costs will come down — and Procter & Gamble will have a good deal of negotiating power with suppliers thanks to its scale — the selling prices of these products will not come down, or at least not nearly as quickly as the input costs. As a result, profit margins should re-expand, causing today's headwinds to be turn into tomorrow's tailwinds. One reason we aren't seeing the costs come down now despite notable declines in many commodities is that Procter & Gamble buys a bit lower down the supply chain. For example, management reminded analysts that the company doesn't actually purchase raw materials like propylene or ethylene, but rather purchases packaging materials. Put another way, it will take a bit longer for the commodity price declines to trickle down into Procter & Gamble's costs. Until then, we are happy to keep collecting the almost 3% dividend, which is compounded by the share repurchase program. However, given the increased currency headwind and prolonged margin pressure resulting from higher input costs, we are revising our price target down to $160 from $165. We maintain our 1 rating on PG shares, meaning we would buy at current prices. Companywide results Pricing power was key this quarter as the operating environment remains plagued by elevated commodity, material, and freight costs. The company is doing a solid job managing costs. Gross margin contracted by 160 basis points (bps) versus the prior year, but a 90 bps cut to selling, general and administrative (SG & A) expenses as a percentage of sales resulted in the operating margin contracting by only 70 bps. On a currency-neutral basis, the operating margin expanded 10 bps annually. Operating cash flow of $4.1 billion came up short versus the $5.9 billion consensus, while adjusted free cash flow productivity, defined as the ratio of adjusted free cash flow to net earnings, came in at 86% for the quarter. On the call, management reported some growth in private label (store brands), which management sees as one proxy for trade downs (consumers shifting to lower-cost products). In the U.S. and Europe, the team has seen a 30 bps increase and 20 bps increase, respectively, over the past three to six months. That's pretty minimal and one way management has been able to maintain overall market share is by factoring trade-down expectations into the product portfolio "by design," with different package sizes. Procter & Gamble highlighted its vertical portfolio as a way to address the two ways it see buyers reacting to inflation. On the one hand, there is a group of consumers factoring in the per-unit cost of goods and opting for increased transaction sizes to reduce the per-unit cost, or buying in bulk. And on the other hand, there is the consumer more concerned with the cash outlay. Management is seeking to address both groups by providing options that fit both consumer preferences. Management, in other words, is focused on value, which is found with the right combination of price, performance and usage experience. This focus on providing the best value for both of those types of consumer is what allows the team to maintain market share while raising prices to protect profits. Lastly, management returned nearly $6.3 billion in cash to shareholders via dividends and buybacks. Segment performance Beauty sales of $3.96 billion, up 4% year over year on an organic basis (in line with expectations), was slightly short of the $3.98 billion consensus. Skin and personal care segment saw a mid-single-digit increase in organic sales on the back of "innovation-driven volume growth" and higher prices. Hair care sales were also up mid-single digits organically as higher pricing was partially offset by lower volumes related to market contraction. Grooming sales of $1.63 billion, an increase of 5% organic year over year (versus a 4% estimate), missed expectations of $1.65 billion. Management said growth in blades and razors was partially offset by a decline in appliances, due in large part to market contraction. Health-care sales of $2.78 billion, an increase of 8% organic over the prior year (versus a 9% estimate), was in line with expectations. The segment benefited from a low-single-digit increase in oral care products thanks to price increases and a positive product mix that was partially offset by lower volumes due to market contraction. Personal health-care sales grew in the high-teens percent, with organic growth seen in all regions, thanks to higher prices, a favorable product mix, and volume growth "driven by a stronger cough, cold and flu season." Fabric and home care sales of $7.08 billion, up 8% organic (versus a 6% estimate), was shy of the $7.13 billion expected. Fabric care organic sales were up high-single digits as price increases were partially offset by volume declines "due to market contraction and market share softness, primarily in Europe." Home care posted a high-single-digit increase in organic sales, with organic growth seen in all regions, thanks to higher prices that were partially offset by "volume declines versus a high base period of increased consumption of cleaning products." Baby, feminine and family care sales of $4.93 billion, up 6% organic (versus a 4% estimate), exceeded the $4.85 billion consensus. Baby care sales increased mid-single digits organically thanks to higher prices that were partially offset by lower volumes that were partly attributable to portfolio reduction in Russia. Feminine care organic sales were up double digits, with growth in all regions, driven by price increases and a positive geographic mix. Offsetting this was volume declines due to portfolio reduction in Russia. Family care organic sales were up low-single digits thanks to higher prices. However, the gains were partially offset by lower market volumes and soft market share. Guidance Management lowered its fiscal year 2023 sales guidance, now expecting sales to fall 1% to 3% versus 2022, versus flat to up 2% previously forecast. This is below the 0.5% decline the Street was expecting coming into the print. However, after accounting for a 6% foreign exchange headwind, up from 3% previously expected, management's organic growth forecast remains unchanged at up 3% to 5%, in line with expectations at the midpoint. Incorporated into the company's reaffirmed EPS guidance are expectations for a $1.3 billion after-tax foreign exchange headwind, a $2.4 billion hit due to higher commodity and material costs, and a $200 million blow due to higher freight costs (though that's less than the $300 million previously expected). Adding that up, management is factoring in a $3.9 billion, or $1.57 per share, after-tax headwind. This compares to prior guidance calling for a total headwind of $3.3 billion, or $1.33 per share, with the $600 million delta primarily driven by foreign exchange. The team continues to expect adjusted free cash flow productivity of 90% and to pay around $9 billion in dividends, and to repurchase $6 billion to $8 billion of common shares in the fiscal year. (Jim Cramer's Charitable Trust is long PG. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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