27 October 2010

PG: Income Statement Analysis for the September 2010 Quarter

Procter & Gamble (NYSE: PG) earned $1.02 per diluted share on a GAAP basis in the September-ending first quarter of fiscal 2011, down 4.2 percent from $1.06 in the same three months of last year.

Core earnings, a non-GAAP measure that excludes certain items and discontinued operations, rose from $0.97 to $1.02 per share.

This post examines P&G's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were $0.06 more than our $0.96 EPS estimate.

The principal sources for this income statement analysis were the earnings announcement and the ensuing conference call (transcript courtesy of Seeking Alpha).

In a second article, we will report P&G's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Procter & Gamble creates and markets many well-known Household and Personal products to customers around the world.  The company, based in Cincinnati, traces its roots back to 1837.

P&G reported Net Income of $12.7 billion ($10.9 billion from continuing operations) on Net Sales of $78.9 billion in fiscal 2010, which ended in June.

The company's market value is currently about $190 billion on a fully diluted basis, which makes P&G one of the ten most-valuable U.S. corporations.

Having raised its dividend for 54 consecutive years, P&G 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.

P&G has three global business units: Beauty and Grooming, Health and Well-Being, and Household Care.  Each GBU comprises two segments.

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.  Consumer products compete at large and small retailers on price, quality, features, and marketing.  P&G has long been a top advertiser

In the last decade, P&G has made an effort "to extend the availability and affordability of P&G brands to more low-income consumers, particularly in developing markets." In 2009, 32 percent of the company's total sales were in developing markets, up from 20 percent ten years earlier.

Additional background information about P&G and the business environment in which it is currently operating can be found in the look-ahead

Please click here to see a normalized depiction of the actual and projected results for the just-concluded quarter, as well as restated quarterly Income Statements for the last couple of years.  After selling its pharmaceuticals business to Warner Chilcott (NASDAQ: WCRX), P&G restated some historical financial statements to depict the pharmaceutical results as a discontinued operation.

Also 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.

Revenue in the September quarter increased 1.6 percent, from $19.8 billion last year to $20.1 billion in the most recent three months.   This rise was consistent with P&G's guidance to expect 1-to-3 percent Revenue growth.

Revenue missed our $20.2 billion estimate by only 0.4 percent.

P&G attributed sales growth to increased product volumes "in all major geographic regions and five of six business segments."  Volume growth increased "double digits in developing regions and mid-single digits in developed regions."  Organic sales, which excludes the effects of acquisitions, divestitures and foreign exchange, grew at 4 percent. 

Negative factors that dampened sales growth included pricing (-1 percent), geographic and product mix (-2 percent), and unfavorable foreign exchange (-3 percent).

Sales rose the most, 3 percent, at the business unit selling Fabric Care and Home Care products. The company's Snacks and Pet Care business was the laggard, reporting sales growth of minus 6 percent relative to the September 2009 quarter.

The Cost of Goods Sold was 48.2 percent of Revenue in the September quarter, which translates into a Gross Margin of 51.8 percent.  When compared to the 52.6 percent Gross Margin in the September 2009 quarter, the margin has become 80 basis points less profitable. 

P&G placed most of the blame for the margin contraction on higher commodity costs.  Product mix also hurt the margin as sales of some lower-profit products rose at a faster pace than the average for the quarter.

Sales, General, and Administrative expenses were nearly flat, slipping from $5.96 billion to $5.93 billion.  As a percentage of Revenue, SG&A fell from 30.1 percent of Revenue in the September 2009 quarter to 29.5 percent in the most recent period.

The SG&A decline was credited to "improved productivity, lower foreign currency exchange costs related to the Company’s operations in Venezuela and reduced overhead spending, partially offset by higher marketing investments to support product initiatives and build brand equity."

The latest SG&A expense was a substantial 8.2 percent less than our $6.46 billion estimate.

Subtracting the various operating expenses from Revenue yields Operating Income of $4.50 billion, just 1.2 percent more than last year's $4.45 billion. Operating Income for the quarter was 6.1-percent weaker than our $4.24 billion estimate.   Lower-than-expected SG&A spending proved to be more consequential than the weaker-than-expected Gross Margin.

The $219-million net expense for Interest and other items was $45 million less than in the same period last year, and it was $31 million less than our $250 million estimate.

The 28-percent effective income tax rate was a tad greater than September 2009's 27.7 percent.  We had assumed the rate would be 27 percent.

Because the prior-year period included $280 million of income from discontinued operations, Net Income fell 6.8 percent to $3.08 billion ($1.02 per diluted share).  Nevertheless, the latest $1.02 EPS exceeded P&G prior guidance range of $0.97 to $1.01.  Income from continuing operations increased from $3.03 billion ($0.97 per diluted share) to $3.08 billion ($1.02 per diluted share). Fewer shares outstanding boosted the gain in EPS terms.

Net Income exceeded our $2.91 billion ($0.96 per share) estimate by about 6 percent.

In summary, modest Revenue growth in the September quarter was consistent with P&G's guidance.  Sales volume increased at a healthy 8-percent rate, but factors such as unfavorable exchange rates kept overall sales growth down to a modest 2 percent.  Higher commodity costs put pressure on the Gross Margin, but this negative factor was outweighed by lower-than-expected SG&A expenses.  A lower expense for interest also helped latest quarter's results.  Overall Net Income was down because the prior period included the results of divested businesses; however, earnings from continuing operations per share rose from $0.97 to $1.02 per diluted share.

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

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