30 March 2010

PG: Look Ahead to March 2010 Quarterly Results

This post describes our model of Procter & Gamble's (NYSE: PG) Income Statement for the third quarter of fiscal 2010, which will end on 31 March 2010.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing 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 personal and household products to consumers worldwide from its Cincinnati headquarters.  The company's brands include Pampers, Tide, Ariel, Always, Pantene, Bounty, Pringles, Charmin, Downy, Iams, Crest, Actonel and Olay.

With such a broad product line, P&G has a lengthy list of competitors.  Colgate-Palmolive (NYSE: CL), Kimberly-Clark (NYSE: KMB),  and Unilever (NYSE: UL) are a few of the better known rivals.  Their products compete at large and small retailers on price, quality, features, and marketing.  P&G has long been a top advertiser

P&G's reported Net Sales of $79 billion in fiscal 2009, which ended last June.  Laundry and diaper products were responsible for 17 percent and 11 percent, respectively, of sales, according P&G's last 10-K.  Sales to Wal-Mart Stores (NYSE: WMT) and its affiliates produced about 15 percent of P&G's Revenue.

The company's market capitalization is currently over $180 billion, which makes P&G the seventh-most valuable U.S. corporation.

P&G, having raised its dividend for 53 consecutive years, has certainly earned its place on the list of S&P 500 Dividend Aristocrats.  P&G is also number 6 on Fortune Magazine's 2010 list of the World's Most Admired Companies.

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.  At a conference in February, P&G Chair and CEO Bob McDonald stated:

"We have the strongest innovation program that I can remember in my 30-year career at P&G, and we are investing behind it to drive growth across our business."

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.

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 87.5 million shares of P&G, worth about $5.3 billion, on 31 December 2009.

Now, we are ready to look ahead to P&G results for the March 2010 quarter.

P&G's earnings announcement in January included the following guidance for the fiscal year and the March quarter:

Fiscal Year 2010 Guidance

Net sales growth is estimated to be three to six percent for fiscal year 2010. Foreign exchange is expected to increase net sales by zero to one percent, while the net impact of acquisitions and divestitures is not expected to have a material impact on net sales. The Company increased its expectations for organic sales growth by one percent to three to five percent versus previous guidance of two to four percent. The Company maintained its previously communicated diluted net earnings per share guidance of $4.02 to $4.12. Diluted net earnings per share from continuing operations are expected to be $3.44 to $3.54. Core EPS guidance increased to $3.53 to $3.63, recognizing improvement in the underlying business. Core EPS is expected to be up two to five percent versus year ago.

January - March 2010 Quarter Guidance

For the January - March quarter, net sales are expected to increase seven to ten percent. Organic sales are expected to grow four to six percent. Foreign exchange is expected to increase net sales by three to four percent, while the net impact of acquisitions and divestitures is not expected to have a material impact on net sales. Diluted net earnings per share, diluted net earnings per share from continuing operations and Core EPS are each expected to be $0.77 to $0.82. Diluted net earnings per share are expected to decline two to eight percent, while diluted net earnings per share from continuing operations and Core EPS are expected to be down five to up one percent versus the prior year period, reflecting commodity, market and investment trends.
 [emphasis added]

At the Consumer Analyst Group of New York (CAGNY) annual conference on 18 February 2010, P&G:
... confirmed its fiscal year 2010 all-in GAAP EPS guidance range of $4.02 to $4.12 and its Core EPS range of $3.53 to $3.63. [...]  When addressing the outlook for fiscal year 2011, P&G said that it is too early in the planning stages to provide detailed guidance, but the company expects to deliver continued strong top-line growth and a sequential improvement in bottom-line growth compared to fiscal 2010.

A 7-to-10 percent growth rate for the quarter would translate into Net Sales, or reported Revenue, between $19.1 billion and $19.65 billion.  We will use the mid-range figure of $19.4 billion as our target for Revenue in the March quarter.

P&G's Gross Margin in the March quarter is usually a percent or so less than in the preceding quarters because Revenue is a little lower.  We're assuming the margin will be 52.1 percent, which is 1 percent less than the average of the September 2009 and December 2009 quarters.  Therefore, our estimate of Cost of Goods Sold is (1 - 0.521) * $19.4 billion = $9.3 billion.

SG&A expenses are normally around 30 percent of Revenue, but it was 31.6 percent in the last quarter.  For the March quarter, we're estimating 31 percent or 0.31 * $19.4 billion = $5.8 billion.

These assumptions would lead to Operating Income of almost $4.1 billion, which is 15 percent more than the comparable amount in the year-earlier quarter.

We expect a net Interest expense of $300 million, and, therefore, pretax income of approximately $3.8 billion.

We're using a 28 percent effective income tax rate, which would lead to a tax provision of $1.1 billion.

Rolling up these figures, we're looking for Net Income from continuing operations of $2.7 billion ($0.87/share).  In last year's March quarter, P&G earned $2.6 billion ($0.84/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. [As a consequence of the sale of the pharmaceuticals business, P&G restated some historical financial statements to reflect the pharmaceutical results as a discontinued operation.  We used this information from the company to update our spreadsheets, making estimates where official data was not readily available.] 

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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