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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.