The Most Impressive Part of Procter & Gamble's Earnings

A cursory look at the news will tell you that inflation is a big issue today, with a quick trip to the local grocery store confirming that fact as buying daily necessities drains more and more cash from your wallet. This is a terrible backdrop for consumer goods stocks, which are facing rising costs of their own. The big question is how well they can pass those costs on to consumers.

Procter & Gamble's (PG 0.68%) latest earnings report strongly suggests it has a leg up on this process.

Image source: Getty Images.

Inflation is not new

Before getting too upset about inflation, investors need to step back and recognize that prices rise over time. It's not at all unusual. In fact, consumer goods companies like Procter & Gamble or Kraft Heinz (KHC 1.31%) are used to dealing with the issue. They have a number of different approaches to fall back on for increasing the amount of money they generate to offset their own rising costs. Examples include simply raising prices or providing smaller portions for the same price. There's a well-honed playbook that all consumer staples companies fall back on.

The problem is that there's a lag between when a company gets hit with rising costs and when it can push those costs on to consumers. Margins, and thus profits, get squeezed during the interim and investors don't generally like that. The real headwind today is the rate at which, and extent that, inflation has been rising lately. In fact, it's likely that companies will have to force through multiple rounds of price increases. Consumers could quickly push back, shifting toward cheaper alternatives. 

So the real question that investors should be thinking about right now is not whether or not consumer goods stocks will raise prices to deal with inflation. (They will.) The better question to ponder right now is how much pricing power companies have. On that front, Procter & Gamble's fiscal second-quarter 2022 results shine.

Good versus bad

Net sales at the consumer goods giant were up a solid 6% in the fiscal second quarter. That alone, however, doesn't tell you enough about what's going on today. You need to dig a little deeper. Notably, price increases added three percentage points to sales, with price increases across all of the company's product lines. Meanwhile, volume added the other three points, again with improvement across each and every product category.

Data source: Procter & Gamble

Those two numbers are important because taken together, they mean that Procter & Gamble was able to raise prices while still seeing increased demand for its products. Simply put, it has pricing power. And, if history is any guide, it will have an easier time than others as it looks to raise prices in the near future to offset still rising input, manufacturing, and logistics costs. 

A comparison will be helpful. In the third quarter of 2021, Kraft Heinz implemented price increases in each of the regions where it operates. Volume was flat in one region (International) and down in the other two (United States and Canada). The price hikes helped push organic sales up by 1.3% overall, but the volume decline, even though small at negative 0.2 percentage points, suggests that there's less pricing power here. In other words, consumers are seeing higher prices for Kraft Heinz products and are starting to look at alternatives. Too many price hikes and the trend could accelerate.

Data source: Kraft Heinz.

Now go back and compare that to Procter & Gamble, which was able to increase prices and volume at the same time. To be fair, increasing consumer prices is a delicate dance. Sometimes companies need to accept a little volume decline in the near term with the benefit of higher prices offsetting the effect. That's pretty much what was going on at Kraft Heinz in the third quarter. The hope is that, in the future, consumers will come back to the brands they shunned because of price increases. That's not as good a position to be in.

Hitting on all cylinders 

Procter & Gamble went through a rough patch a few years ago that included jettisoning a large number of underperforming businesses. That goal was to hunker down and focus on its biggest and best brands. Given the pricing strength it appears to have today, as it faces material inflation for the first time since the divestitures, it seems like the portfolio makeover is paying off in a big way.

While every quarter may not be this good, Procter & Gamble shareholders should be very pleased with what they are seeing right now. This consumer goods behemoth is proving why it is an industry bellwether.