P&G Pays the Price for Growth

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After originally getting its mojo back at the end of 2009, consumer-goods giant Procter & Gamble (NYSE: PG  ) continues to grow sales and product volume. These improving metrics, however, are taking their toll on profit growth. Judging by share price action, the market doesn't like the trade-off.

Does Mr. Market have it right? Let's dig deeper.

Fiscal 2010 third-quarter sales of $19.2 billion represent a 7% year-over-year gain. Organic sales, which strip out the effects of currency movements and acquisitions and divestitures, rose a lesser 4%. For comparison, two of the company's biggest competitors, Kimberly-Clark (NYSE: KMB  ) and Colgate-Palmolive (NYSE: CL  ) , recently posted organic sales improvements of 2% and 6%, respectively.

The key to the market's reaction, however, likely rests more with the details of P&G's post-recession strategy than with peer comparisons. Here, we see that lower overall pricing reduced sales by 1%. (Of course, we already had strong indications of this development.) Furthermore, gross margin expansion of 2.9 percentage points dwindled to a 0.8 point increase at the operating line, owing primarily to higher marketing costs. In other words, to sell more goods, P&G is bringing down prices and stepping up advertising.

Ultimately, quarterly earnings per share from continuing operations advanced 6%, to $0.83. Apparently, that wasn't good enough for the market.

Yet those results look decent to me, especially given that we're still in the early innings of P&G's product portfolio shake-up. Moreover, "core EPS," which excludes items such as charges related to health-care reform, gained a larger 10%.

Volume performance was also encouraging; the company posted a monster jump of 7%. True, that figure is less impressive when we consider the volume in the year-ago quarter fell 5%, but it nonetheless shows that P&G is regaining traction with consumers in a major way.

Looking forward, management expects to round out fiscal 2010 with net sales growth of 3%-5% and core EPS gains of 4%-6%. However, the top end of earnings guidance for the fourth quarter fell $0.02 per share short of analyst estimates, which offered investors another excuse to leave shares on the shelf.

The essential point to keep in mind is that P&G needs time to fine-tune its strategy. In terms of developed-market consumers, we likely are in a new normal, at least when it comes to everyday goods. P&G may never again recapture its mid-to-high double-digit income growth of the pre-recession years.

At a forward price-to-earnings ratio of 15.3, those dour possibilities appear priced in. Plus, based on that same forward metric, P&G trades at a discount to cyclicals such as Joy Global (Nasdaq: JOYG  ) , Honeywell, Caterpillar (NYSE: CAT  ) , and Cummins. Those are all fine companies in my view, but as the economic cycle matures, a company such as P&G could become the relative value leader.

On today's pullback, I once again reiterate my best estimate that P&G is a buy.

Kimberly Clark and Procter & Gamble are Motley Fool Income Investor selections. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletters, free for 30 days.

Fool contributor Mike Pienciak holds no financial interest in any company mentioned in this article. The Fool has a disclosure policy.

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10/21/2016 4:01 PM
PG $84.33 Down -0.60 -0.71%
Procter and Gamble CAPS Rating: ****
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CL $70.92 Down +0.00 +0.00%
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JOY $27.89 Up +0.02 +0.07%
Joy Global CAPS Rating: ****
KMB $119.58 Up +0.41 +0.34%
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