The premise is troubling enough. Procter & Gamble (PG 0.13%) may be passing along most of its cost increases to customers right now, but how long can that last? Management for the consumer goods giant is clearly concerned enough to make a point of discussing the matter during last quarter's conference call. Smart investors notice such nuances.
Largely lost in the rhetoric, however, is perspective. P&G may be facing internal inflation, but the actual numbers involved are hardly devastating compared to the company's typical profitability.
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What P&G management said
CFO Andre Schulten explained during the company's fiscal 2021 fourth-quarter conference call:
Input costs have risen sharply. Current spot prices for materials such as resins, chemicals, and other ingredients are up anywhere from 30% to 200% versus April 2020. Most of the material cost increases occurred in this calendar year and will disproportionately affect the first half of fiscal 2022.
And he's right. These rising costs will not only take a toll in the future, but they have already crimped margins. Schulten adds to his discussion regarding recently completed fiscal 2021:
... core earnings per share were $1.13, down 3% versus prior year; down 4% on a currency-neutral basis, mainly due to gross margin pressure from higher input cost as we had anticipated. Core gross margin decreased 260 basis points. Currency-neutral core gross margin also down 260 points. This includes 220 basis points impact from higher commodity and freight costs; nearly $400 million in just this quarter."
Schulten goes on to say about the foreseeable future:
Based on current spot prices, we estimate a $1.8 billion after-tax commodity cost headwind in fiscal '22. Freight costs have also increased substantially ... . We currently expect freight and transportation costs to be an incremental $100 million after-tax headwind in fiscal 2022.
Sounds rough. It seems as if Procter & Gamble is going to have to fight for every penny it manages to shove down to the bottom line.
As was noted, though, the discussion doesn't include some much-needed perspective on the matter.
Other numbers that matter just as much
Clearly, it would be better for shareholders if P&G weren't facing rising costs. But let's not lose sight of the bigger picture.
Take the $1.8 billion after-tax commodity cost headwind Schulten mentioned as an example. That's a sizable chunk of change. But it's a manageable figure in comparison to the $37.1 billion cost of the $76.1 billion worth of goods Procter sold last fiscal year. It's also a relatively modest piece of the $35.3 billion P&G spent to buy, make, or procure the previous year's $71 billion worth of goods sold, before the COVID-19 pandemic had fully taken hold. Schulten also intimated that the cost increases in question were already reflected on the company's books, suggesting costs at least won't progressively worsen from current levels as the current year wears on.
Ideal? No. But, it's certainly survivable, particularly in light of what wasn't discussed during the Q4 conference call. That's the impact of cost-cutting efforts that have been underway for some time.
The specifics: Selling and administrative expenses fell 30 basis points last year, or 0.3% of sales, as a result of streamlining, and fell by even more on a currency-neutral basis. Productivity savings and price increases improved last year's bottom line by 230 basis points, or 2.3% of sales. All told, last year's productivity cost-savings benefit totaled up to 320 basis points, or 3.2% of sales. Clearly, the company's long-term savings efforts are at least partially offsetting rising expenses.
And the simplest of calculations confirms the consumer goods outfit is anything but on the fiscal defensive here. The company still converted 18.8% of last fiscal year's revenue into net earnings, versus the prior year's comparison of only 18.3%. In fiscal 2019 and 2018, those earnings margin rates were 18% and 15.5%, respectively.
Sure, last quarter's comparable figure was markedly lower at 15.3%. That contraction, however, can be attributed to the sheer pace at which input costs grew; a bunch of shellshocked companies were sent scrambling just a few weeks back. Last quarter's metrics aren't fit for use as a long-term yardstick.
Bottom line
To their credit, investors haven't completely fixated on Procter & Gamble's rising costs, although the topic has dominated discussions since the release of Q4 numbers on July 30. And to a certain extent, this makes sense. There's not much need to look at the predictable and nominal data. It's the unexpected that makes or breaks a stock.
This is a case, however, where the rhetoric surrounding one aspect of a company's operation has distracted investors from a more important reality. That is, Procter & Gamble is navigating this tricky environment pretty well. Earnings still improved 11% last year on a 6% uptick in organic revenue. This year's revenue is projected to grow between 2% and 4%, driving profit growth of between 3% and 9%, depending on how the figure is calculated. And that's with the cost headwind the company concedes that most investors already knew was blowing anyway. Not bad, all things considered.
The point is, if the rising-cost headlines have soured you on the idea of stepping into P&G, don't sweat them. Input and operating costs ebb and flow all the time for all companies. This isn't anything Procter & Gamble can't easily power through despite the current inflation narrative.
