20 September 2009

PG: Look Ahead to September 2009 Quarterly Results

The GCFR Overall Gauge of Procter & Gamble's (NYSE: PG) dropped from 52 to 44 of the 100 possible points in the June quarter.  This period was the fourth quarter of P&G's fiscal 2009.

Our income statement, financial gauge, and gauge update analyses explained in some detail how the score was attained.

In the June quarter, earnings fell to $0.80 per diluted share from $0.92 in the same period last year ($0.90 excluding income from discontinued operations).  The June 2008 quarter benefited from "significant adjustments to tax reserves."  Revenue skidded 10.6 percent, but the company indicated that the stronger U.S. dollar caused much of the decline.  A rising greenback diminishes the reported value of non-U.S. sales.

We have now modeled P&G's Income Statement for fiscal 2010's first quarter, which will end on 30 September.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce in October.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about P&G and the business environment in which it is currently operating.  Readers that keep close tabs on the company might want to skip ahead.

Procter & Gamble, which traces its roots back to 1837, sells well-known consumer products from its Cincinnati headquarters.  The company's brands include Pampers, Tide, Ariel, Always, Pantene, Bounty, Pringles, Charmin, Downy, Iams, Crest, Actonel and Olay.

P&G's output is sold by large and small retailers around the world.  These products compete on price, quality, features, and marketing.  A fundamental aspect of P&G's strategy is to invest in Research and Development -- roughly $2 billion annually, conducted internally and externally -- to create innovative products deserving of premium pricing and brand loyalty.  The company's trademarks are highly valued assets.

According P&G's last 10-K, laundry and diaper products were responsible for 17 percent and 11 percent, respectively, of net sales in fiscal 2009.  About 15 percent of Revenue was from sales to Wal-Mart Stores (NYSE: WMT) and its affiliates.

Because consumers consider each dollar more precious in a recession, P&G can lose market share to competitors that offer lower-priced products.  The WSJ reported P&G will (reluctantly) reduce prices and increase promotions in certain areas to regain market share.

Berkshire Hathaway (NYSE: BRK.A), run by investing guru Warren Buffett, owned 96.3 million shares of P&G, worth almost $5 billion, on 30 June 2009.

P&G adds and divests brands regularly.  The company acquired razor-titan Gillette in October 2005 for $57 billion.  P&G sold the Folgers coffee business in 2008 to J.M. Smucker (NYSE: SJM).  In August 2009, P&G agreed to sell its pharmaceutical business to Warner Chilcott (NASDAQ: WCRX).

P&G consumes considerable quantities of raw materials and is, therefore, subject to commodity price fluctuations.

Now, we are ready to look ahead.

P&G's press release in August announcing the previous quarter's results included the following guidance for the September quarter:

July - September 2009 Quarter Guidance

For the July - September quarter, P&G expects organic sales growth of zero to negative three percent. Foreign exchange is expected to reduce net sales by about seven percent resulting in net sales down seven to 10 percent versus the prior year. Earnings per share from continuing operations are expected to be $0.95 to $1.00. While P&G does expect some non-operating gains as a result of ongoing portfolio optimization in the July - September quarter, the earnings growth rate will be negatively impacted by the comparison to a base period that included several divestiture gains.

The guidance was updated on 10 Sept.

July – September Quarter Guidance

For the July – September quarter, P&G confirmed expectations for organic sales growth of zero to negative three percent. Foreign exchange is expected to reduce net sales by about seven percent resulting in net sales down seven to 10 percent versus the prior year. The Company continues to estimate all-in earnings per share of $0.95 to $1.00 for the quarter.

For readers unfamiliar with the phrase "organic sales growth," P&G has provided a definition:

Organic sales growth is a non-GAAP measure of sales growth excluding the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. We believe this provides investors with a more complete understanding of underlying sales trends by providing sales growth on a consistent basis.

If the cited 7-to-10 percent Revenue decline is applied to last year's (restated) $21.6 billion, the guidance suggests a Revenue target somewhat below $20 billion.  For our purposes, we will set $19.8 billion as the target.

Although P&G's Gross Margin in the September 2008 quarter was 50.8 percent (and 53.2 percent one year earlier), our expectation for the current quarter is the 50.3 percent in the June 2009 quarter.  If this margin is attained, the Cost of Goods Sold should be (1 - 0.503) * $19.8 billion = $9.8 billion.

For SG&A expenses, 30 percent of Revenue is a reasonable rule of thumb.   Therefore, our assumption for these costs is 0.30 * $19.8 billion = $5.9 billion.

These assumptions would lead to Operating Income, as we define it, of $4.0 billion.  This figure is 12 percent less than Operating Income in the year-earlier quarter.  Note that this estimate does not include any gains or losses related to the sale of the pharmaceutical business to Warner Chilcott.

We expect a net expense for Interest of $330 million and non-operating income of $250 million.  (We're very uncertain about the latter amount.)  Note that the September 2008 quarter included significant one-time, non-operating gains on the sale of ThermaCare to Wyeth (NYSE: WYE) and the sale of Dantrium® to JHP Pharmaceuticals and SpePharm Holding.  P&G indicated that the one-time gains would not be as great in the current quarter.

This would result in pretax income of approximately $3.9 billion.

We're using a 25 percent effective income tax rate, which would result in a tax provision of $985 million.

Rolling up these figures, we're looking for Net Income of $2.96 billion ($0.96/share).  In last year's September quarter, P&G earned $3.35 billion ($1.03/share).

Please click here to see a full-sized, normalized depiction of the projected results next to P&G's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: No position in PG at time of writing.

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