Over the past several quarters, rising commodity and transportation costs have applied major pressure on margins for consumer goods companies like PG and peers Clorox (CLX), Colgate-Palmolive (CL), and Kimberly-Clark (KMB). Yesterday, KMB issued Q1 results and it too reported that gross margin stabilized on a yr/yr basis, flat at 17.4%. The big difference is that PG's core gross margin is significantly higher at 49.2%.
Given PG's strong and improving results, it begs the question, "why is the stock trading lower today?"
We believe the weakness is mainly attributable to the sharp run higher the stock has enjoyed over the past year. Since late April 2018, shares have rocketed higher by over 40%. That move is more akin to a high-growth tech stock, rather than a stable, income-generating name like PG. With the move higher, its valuation has become rather rich with a trailing P/E upwards of 32x. For a couple points of comparison, CL and CLX are trading with a trailing P/Es of 25x.
Additionally, PG chose not to revise its FY19 EPS guidance higher, despite lifting its organic growth outlook. That could be providing some disappointment as well, but in our opinion, the pull-back is probably mostly due to some profit taking.
Circling back to PG's quarterly results, EPS were $1.06, topping the $1.04 consensus, on revenue of $16.46 bln, also in line with expectations. Organic sales, which exclude the impact of divestitures, acquisitions, and FX, increased by a healthy 5%, improving on last quarter's +4% mark. While four of its five major businesses posted yr/yr growth - the exception being grooming - there were a couple standouts.
The beauty category continues to be a key growth driver, achieving organic sales growth of 9%, following Q2's 8% increase. Within this category, Skin and Personal Care products exhibited strength, growing in the mid-teens as positive mix and disproportionate growth from its super-premium SK-II brand provided a lift. The other notable outperformer was the Health Care segment, up 5% yr/yr, as strong volume and positive sales mix from premium toothpaste and toothbrush products helped.
Underlying PG's solid performance has been its strategy to focus its investments on its strongest brands, especially in daily use categories where it holds a number one or two market position. Historically, these brands have grown faster than the rest of the company, and, have been more profitable. This plan seems to be paying off as 33 of its top 50 product categories held or grew their market share year-to-date, according to PG.
Turning to margins, gross margin improved by 60 bps on a currency-neutral basis. This was driven by 160 bps of productivity savings and 80 bps of pricing benefits, partially offset by a negative 70 bp impact from commodity costs. The fact that PG was able to push through higher prices, while generating solid organic sales growth, is a testament to its brand name, as well as the health of the consumer.
Thanks to its better-than-expected Q3 report and the easing cost pressures, PG boosted its FY19 organic sales growth guidance from a range of 2-4%, to 4%. The company maintained its core EPS guidance, still expecting growth of 3-8% yr/yr. With commodity and transportation costs remaining volatile, PG seems to have taken a slightly more cautious approach to its earnings outlook.
Key Takeaways: PG continues to demonstrate why it's the marquee name in the consumer staple sector, once again exceeding earnings expectations while driving superior organic sales growth. Its ability to pass through rising costs illustrates that consumers are willing to pay up for its products. At the same time, the company has been reining in expenses, particularly in its supply chain, and has been deploying capital to buy back stock and increase its dividend. Despite today's weakness, it is evident that PG is executing quite well and it remains an attractive option for income-minded investors.