29 November 2010

PG: Financial Gauge 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.

A previous article examined in some detail P&G's Income Statement for the September quarter.  Reported earnings were $0.06 more than our $0.96 EPS estimate.

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for P&G and the associated financial gauge scores.  The metrics were calculated using data from P&G's current and historical financial statements, including those in the latest 10-Q report.

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

In summary, P&G's latest quarterly results produced the following changes to the gauge scores:
  • Overall: 37 of 100 (down from 49)

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

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.  We used the latest numbers when computing the financial metrics listed below.

Cash Management30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Current Ratio0.
LTD to Equity34.0%34.8%33.5%36.7%
Debt/CFO (years)
Inventory/CGS (days)65.665.375.469.8
Finished Goods/Inventory63.7%64.0%66.6%66.5%
Days of Sales Outstanding (days)27.727.630.830.5
Working Capital/Revenue-5.2%-5.7%-12.9%-5.4%
Cash Conversion Cycle Time (days)34.834.349.351.5
Gauge Score (0 to 25)1718117

The Cash Management gauge slipped one point but a 17-point score is still a very good result.

In the September quarter, the Long-term Debt-to-Equity ratio fell slightly because equity increased and LTD barely changed.  Short-term debt, however, rose from $8.5 billion to $11.5 billion.   It was this hike in Short-term Debt (i.e., obligations due within one year) that caused Total Debt to increase relative to Cash Flow from Operations.

P&G's Inventory has become very much leaner in the last year, reversing earlier increases.  A  nearly 10-day decline is rather remarkable, and the lower percentage of Finished Goods is also positive.

Days of Sales Outstanding and the Cash Conversion Cycle Time, which are related measures of cash management efficiency, have both improved.

Although it's not appropriate for every company, P&G's ability to operate with negative Working Capital can also be viewed as sign of efficient use of Cash.

Growth30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Revenue Growth4.9%2.9%-6.8%1.7%
Operating Profit Growth2.4%3.2%5.5%4.1%
CFO Growth-12.9%7.7%5.3%8.6%
Net Income Growth3.9%2.5%-8.0%9.2%
Gauge Score (0 to 25)111339
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

The Growth gauge ceded a couple of points because a big decline in Cash Flow from Operations (down 46 percent in the September quarter) outweighed small improvements in Revenue and Net Income growth.

One reason for the lackluster growth rates is that is that P&G has divested certain businesses.  The divestitures might have contributed to the improvement over the last year in the Revenue-to-Assets ratio.  If this ratio were to get back over 60 percent, it would have a greater positive effect on the Growth gauge score.

Currency exchange rates have also had negative effects on sales in some periods.

Profitability30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Operating Expense/Revenue79.7%79.7%79.6%79.9%
Free Cash Flow/Invested Capital11.5%14.1%13.2%12.5%
Accrual Ratio-0.2%-2.1%-0.2%-0.7%
Gauge Score (0 to 25)71188

The Profitability gauge suffered primarily because weak Cash Flow (mentioned above) had a negative impact on the FCF and Accrual Ratios.

Although P&G has had some success improving its Gross Margin, the overall Operating Margin has been stuck at about 20 percent (i.e., operating expenses take $0.80 of every sales dollar).  The company has been willing to spend to grow market share and to support new products.

The improvement in the Return on Invested Capital during the last year was smaller than we might have expected.

Value30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)610168
Share Price ($)$59.97$59.98$57.92-

The Value gauge fell because the P/E multiple seemed high and the EV/CFO multiple rose with declining Cash Flow.  P&G's share price didn't change appreciably during the September quarter.

The Price/Sales ratio has been fairly static.

It will take more robust Revenue growth and the resumption of Cash Flow growth to impel the Value score higher.

Overall30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Gauge Score (0 to 100)37494531

The Overall gauge tumbled on weakness in the Profitability and Value gauges.  It will be interesting to see if the recent drop in Cash Flow from Operations, which put negative pressure on several of the scores, proves to be a short-term phenomenon.

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

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