Image source: Getty Images.
Procter & Gamble (PG +0.12%) closed out its fiscal 2016 on an upbeat note, having managed just its second improvement in organic sales growth in nearly three years. The consumer goods giant also booked encouraging volume gains in each of its five key product divisions.
However, P&G came up far short in two of its fundamental business goals over the past 12 months. And unless it can turn the tide on these metrics, the stock is likely to underperform the market from here.
The retailer's competitive strategy is simple: Use a deep portfolio of blockbuster brands -- in combination with a world-class selling infrastructure -- to deliver increasing returns to shareholders.
There are three financial metrics that form the foundation for that lucrative model: organic sales, profits, and cash flow. As executives explain in the 10-K report, P&G aims to 1) improve sales at above-market growth rates; 2) generate high-single-digit earnings gains; and 3) produce free cash flow that's at least 90% of adjusted profits. The company didn't deliver on its first two targets this year.
Market-share losses
Organic sales grew at a 1% pace in fiscal 2016, marking the second straight year of deceleration on this metric (growth was 2% and 3% in 2015 and 2014, respectively). Rivals Unilever (UL +1.32%) and Kimberly-Clark (KMB 0.74%), in contrast, have been growing at between 3% and 5% as of late.
By P&G's estimate, the company lost global market share in each of its major product categories, with the exception of fabric and home care, which was flat:
|
Category |
Market-Share Change |
|---|---|
|
Beauty |
(1%) |
|
Grooming |
(1%) |
|
Healthcare |
(1%) |
|
Fabric and home care |
N/A |
|
Baby, feminine, and family care |
(1%) |
Source: P&G financial filings.
The flat result in fabric is encouraging, given that it is P&G's biggest, most profitable segment. Executives hope to apply the innovation and advertising successes they've managed there to other areas of the business. Investors can judge the success or failure of those initiatives by watching the company's organic growth rates over the next few quarters. P&G aims to speed up to a 2% pace in fiscal 2017, which implies at least steady market share in its key competitive markets.
Earnings declines
Rather than highlighting reported per-share profits, which can fluctuate wildly in a period of major portfolio changes like this, management focuses on what they call core earnings. Instead of rising at a consistent 6% to 8% clip, this metric started low in 2014 and has gotten worse since then.
Image source: P&G investor presentation.
The picture improves markedly when you adjust for foreign-currency swings. By that measure, gains in core earnings per share were 7% in fiscal 2016. However, that was down from 14% in 2014 and 11% in 2015.
P&G has more control over this metric since cost cuts can power improvements even if sales growth rates are weak. And that's exactly what's happened lately. The company has sliced billions of dollars out of its expense structure and plans to deliver another $10 billion of savings over the next five years. For the coming fiscal year, meanwhile, P&G believes it can get back on its long-term growth track by generating core EPS gains of around 6%.
Cash flow for the win
Thanks in part to those aggressive cost cuts, P&G nailed its third core financial goal. Adjusted free-cash-flow productivity amounted to 115% this year, compared to the 90% annual target that CEO David Taylor and his executive team strive to hit. As a result, the company is in a good position to fund increasing cash returns to shareholders over the next few years.
Long term, share repurchases and dividend spending will need an assist from higher sales and profit growth. Robust organic growth is a must for P&G to claim it has truly recovered its long-term expansion pace.
