17 December 2009

PG: Look Ahead to December 2009 Quarterly Results

Procter & Gamble (NYSE: PG) surpassed expectations by earning $1.06 per diluted share in the three months that ended 30 September 2009, which was the first quarter of fiscal 2010.  Net income was $1.03 per share in the same quarter last year.

In October, we examined P&G's Income Statement for the September quarter and compared the entries on each line to our "look-ahead" estimates.  We later performed a financial gauge analysis of P&G, which determined that the GCFR Overall gauge slipped negligibly from 44 to 43 of the 100 possible points.

We have now modeled P&G's Income Statement for the quarter that will end on 31 December 2009.  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 late January or early February 2010.  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.

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.

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.

P&G products are sold by large and small retailers around the world.  The various items compete on price, quality, features, and marketing.  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.  Sales to Wal-Mart Stores (NYSE: WMT) and its affiliates produced about 15 percent of P&G's Revenue.

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).  In December 2009, P&G agreed to acquire Ambi Pur, "a leading global air care brand," from Sara Lee (NYSE: SLE) for about $470 million.

A. G. Lafley -- Chairman of the Board, former Chief Executive Officer, and 32-year P&G employee -- will retire in early 2010.  He will be succeeded as Chairman by Robert A. McDonald, who is already President and CEO.

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.

P&G consumes considerable quantities of raw materials and is, therefore, subject to commodity price fluctuations.  With more than 60 percent of net sales outside the U.S., according to its last 10-K, P&G also has to deal with changing currency conversion rates.  Increasing business in emerging markets is a key part of P&G's current strategy.

Berkshire Hathaway (NYSE: BRK.A), run by investing guru Warren Buffett, owned 96.3 million shares of P&G, worth more than $5.5 billion, on 30 September 2009.

Now, we are ready to look ahead.

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

October - December 2009 Quarter Guidance

For the October - December quarter, the Company expects organic sales growth of two to five percent. Net sales are expected to increase three to seven percent versus the prior year. Foreign exchange is expected to add one to two percent to net sales growth. Diluted earnings per share are expected to be $1.36 to $1.44 including an estimated $0.43 gain on the sale of the global pharmaceuticals business. The final gain amount will be provided in January with the December quarter results. Core earnings per share are expected to be $0.91 to $1.00, an increase of one to 11 percent versus prior year which included very high commodity costs. 
[emphasis added]

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 3-to-7 percent growth rate is applied to the $20.4 billion of Net Sales in the December 2008 quarter, the guidance suggests Revenue will be between $21.0 billion and $21.8 billion.  We are setting $21.4 billion as our target.

P&G's Gross Margin in the September 2009 quarter was 52.6 percent, which was a couple points higher than it had been in recent quarters.  We are being more conservative and looking for 51.8 percent in the current quarter.  If this margin is attained, the Cost of Goods Sold should be (1 - 0.518) * $21.4 billion = $10.3 billion.

SG&A expenses have been about 30 percent of Revenue recently.  For the December quarter, this rate translates into 0.3 * $21.4 billion = $6.4 billion.

These assumptions would lead to Operating Income, as we define it, of almost $4.7 billion.  This figure is 10 percent more than Operating Income in the year-earlier quarter.

We expect a net Interest expense of $300 million, and we're guessing the pretax gain on the sale of the pharmaceutical business to Warner Chilcott will be around $1.7 billion. 

This results in pretax income of approximately $6.1 billion.

We're using a 27 percent effective income tax rate, which would lead to a tax provision of $1.6 billion.

Rolling up these figures, we're looking for Net Income of $4.4 billion ($1.43/share).  In last year's December 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.

1 comment:

  1. I would be very much interested in hearing your opinion about valuation of PG and implied forecast of financial performance of the company presented at iStockResearch website: