P&G Struggles With Sales: Will Cost Savings Help Margins?

We issued an updated research report on The Procter & Gamble Company (NYSE:PG) on May 23, 2016.

On Apr 26, P&G announced decent third-quarter fiscal 2016 results with both earnings and sales beating the Zacks Consensus Estimate. However, adjusted earnings of $0.86 per share were flat on a constant currency basis as the strong operating margins were offset by a higher tax rate, weak sales and the negative impact of Venezuela deconsolidation.

Sales declined 7% to $15.76 billion in the quarter due to currency headwinds, slower market growth, lower sales in developing markets, brand divestures and the negative impact of Venezuela deconsolidation. Organically (excluding the impact of acquisitions, divestitures, foreign exchange and Venezuela deconsolidation), revenues inched up 1%, less than an increase of 2% in the previous quarter, due to softer pricing.

P&G has been struggling to grow sales over the past many quarters. Weak sales have been overshadowing margin improvement from pricing gains and cost cuts. Significant Fx headwinds, weak volumes, and slowing market growth – mainly in developing markets – have been denting sales. Brand divestures and management’s portfolio reshaping measures are also hampering P&G’s sales.

P&G operates in a challenging and volatile macro environment. Market growth rates are constantly decelerating, mainly due to slow growth in developing markets, which is hurting sales. Global market growth in P&G’s categories has decelerated from 4% a year ago to 3% at present, mainly due to slowdown in emerging markets.

The sales trends of the Zacks Rank #3 (Hold) company are not expected to improve much in fiscal 2016. The top line is likely to remain under pressure due to broader macro headwinds like economic slowdown in China and Brazil and significant currency issues in Russia, Ukraine, Japan and Venezuela.

However, the company is investing in its brands and products as well as re-designing the supply chain to boost productivity and organic growth.

Moreover, under its portfolio strengthening and simplification plans announced in Aug 2014, P&G aims to streamline its business and focus more on its biggest brands including the Billion Dollar Brands like Tide, Pampers and Oral-B. Under the plan, that is nearing completion, the company has eliminated almost 60% of the brands (roughly 105 brands) that were witnessing decline in sales and profits.

Following the closure of the beauty brands merger with Coty, Inc. (NYSE:COTY) in the second half of this year, P&G will have a portfolio of about 65 consumer and shopper preferred leading brands focusing on 10 categories organized under four industry-based sectors. Historically, these brands have grown faster and have been more profitable than others.

Under the deal, the company also divested its Duracell batteries business this February to Warren Buffet’s company, Berkshire Hathaway (NYSE:BRKa), Inc. BRK.B, in exchange for Berkshire’s equity stake in P&G. In 2014, the company sold its American and Asian pet care business to Mars, Inc. in July and the European pet care business to Spectrum Brands Holdings, Inc. (NYSE:SPB) in December.

Though this portfolio-reshaping plan is likely to hurt near-term sales/profits, it will ultimately increase profitability.

Importantly, P&G’s productivity improvements and aggressive cost-saving efforts have consistently improved margins and the trend expected to continue in the future.