The Procter & Gamble Company - Q2 results show why it remains an investor favorite
In this post, we review PG's fiscal Q2 results and provide our medium-term financial estimates for the company in order to determine whether they are attractively valued.
We have been holding PG shares for quite a while now in our portfolio for obvious reasons. The company is one of the steadiest in the world and is a great inflation and volatility hedge. Something we deem critical in any portfolio. This is what we wrote on Seeking Alpha most recently:
While the company may not have been a winner over the last decade in terms of financial performance, the company today is well-positioned to deliver market-matching results over the next few years.
Procter & Gamble emerges as a steadfast fortress for investors seeking stability and growth in a volatile economic landscape marked by high inflation and rising interest rates. As a globally renowned consumer goods conglomerate, PG boasts an extensive portfolio of essential products that transcend market cycles.
PG reported fiscal Q2 results earlier this week and surely did not disappoint, with shares up almost 6% over the last five days. PG reported a Q2 organic sales growth of 4%, which led to a slight miss on revenue at $21.44 billion. Furthermore, this is a growth slowdown from 7% organic growth in Q1, primarily due to a far lower impact from price increases. For reference, the contribution from pricing in Q2 was down to just 4% from 7% in Q1.
Looking at the Q2 volumes, at first sight, I was slightly disappointed as volume growth remained in negative territory. The likes of PG, CL 0.00%↑, UL 0.00%↑, and many other consumer staples stocks have received quite some criticism for their dependence on price increases to fuel growth, and I could not agree more.
With inflation easing, these companies can no longer count on price increases to fuel organic growth, which is why I have been focusing on volume growth to support sustainable long-term growth and a healthy investment thesis.
With PG still reporting a negative 1% contribution to growth from volumes in Q1, it wasn’t great. However, it is essential to dive a bit deeper as this shows that volume growth has, in fact, been trending upward quite strongly in most regions.
As reported by management during the earnings call, “over the last five quarters, volume growth in North America has been minus three, flat, then 2% growth plus 3% and now plus 4%,” showing a very strong and improving trend, driving 5% organic sales growth. Meanwhile, in Europe, volumes were up 3%, driving organic sales growth of 7%, which is impressive.
In both these regions, volume accelerated and at least mostly offset the pricing slowdown. This should be seen as a great improvement as demand is clearly returning as price increases moderate, supporting steady and sustainable growth.
The big drag on both volume and organic growth was Greater China, which saw a 15% contraction in organic sales as the underlying market was down by mid to high single digits as consumer confidence weakened further. This was a drag on PG’s result but quite impressively offset by strong trends in its largest (Western) markets.
Even as the company faced several headwinds, trends remained solid, which deserves some praise. Furthermore, the company’s long-term China opportunity remains intact, even as it faces some challenges in this region in the near term, according to management.
The good news continued on the bottom line, with core EPS up 16% YoY to $1.84, beating the Wall Street consensus. This was driven by a 520 bps gross margin improvement and a 400 bps improvement in the core operating margin, even in the face of increased marketing investments, wage and benefit inflation, and foreign exchange impacts.
Again, it was a very solid performance, helped by a 340 bps tailwind from efficiency improvements and a lower impact from inflation on costs.
These improved margins also drove a solid FCF generation of $4.3 billion in Q2, easily covering shareholder returns of $3.3 billion, consisting of $2.3 billion in dividends and $1 billion in share repurchases. For reference, shares yield 2.5%, roughly in line with historical averages, on a healthy 58% payout ratio. Moreover, the company is in a healthy financial position with $7.9 billion in cash on the balance sheet against a very manageable $23.1 billion in debt.
Moving to the outlook, there is even more good news, as the strong Q2 performance has allowed management to update its EPS guidance and reaffirm its revenue guidance. Management now guides EPS growth between 8% and 9% (from a previous 6% to 9%), reflecting a slowdown in margin expansion in H2 and fiscal FY24 EPS of $6.44, according to our estimates.
Meanwhile, management now expects revenue to come in at the high end of the guided 4% to 5% growth range, which we believe should represent a fiscal FY24 revenue of just over $85 billion.
As with all stocks we own, we provide detailed financial estimates of our own, and following these Q2 results, we saw some room for positivity, leading to the following estimates through FY27.
We actively bought. PG shares in recent months when it traded around the $145 level, a valuation slightly below historical levels. However, shares have gained a few percentages over recent weeks and have now returned to their historical averages of just over 24x this year’s earnings, which means these are now fully priced again.
Even as the medium-term EPS outlook has improved slightly, we still view a 24x multiple as fair as it sits in line with historical levels while the company is arguably slightly better positioned compared to the last 5-10 years.
Based on this view, we now set a price target of $179 on the shares, based on the fiscal FY26 EPS estimate above. This means that from a current level of $156, investors should expect limited annual returns of just 5.6% or closer to 8% when including dividends.
All in all, PG delivered a remarkably strong quarter that deserves some praise. Crucially, all trends point in favor of our long-term bull case. The company operates a focused portfolio of products and daily use categories with incredible brand strength, “delivering broad-based growth across nearly all categories and most geographies for several years,” as pointed out by management.
As long as the company is able to grow volumes in line with GDP growth and use pricing to offset inflation, it should be able to keep growing organic sales consistently in a range of 3-5% annually. Considering this company’s history and global strength, this should be very much achievable.
On top of this, it can leverage investments in product, supply chain, and packaging innovation to improve margins and grow EPS by mid to high single digits, making it a very interesting option.
However, shares have now returned to historical averages and are fully priced. Therefore, we are no active buyers of PG stock right now and keep looking for slight dips in the share price, ideally below $147 per share, before adding to our position. Therefore, we rate shares a “Hold.”
Thank you for reading this post. Please remember that this is no financial or investment advice and is for educational and informative purposes only. We are simply sharing our views, actions, and opinions, which I hope will be insightful!
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Disclosure: I/we do have a beneficial long position in the shares of PG either through stock ownership, options, or other derivatives. This article expresses my own opinions and we are not receiving any sort of compensation for it.
No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The information provided in this analysis is for educational and informational purposes only. It is not intended as and should not be considered investment advice or a recommendation to buy or sell any security.
Investing in stocks and securities involves risks, and past performance is not indicative of future results. Readers are advised to conduct their own research before making any investment decisions.