Consumer staples bellwether Procter & Gamble (PG -0.07%) has been performing well despite the impact of heightened inflation. It recently reported another strong quarter to end fiscal 2022. However, management had some words of caution about the future. Investors should heed the warning.
A good quarter to end a good year
In Procter & Gamble's fiscal fourth quarter, it posted organic sales growth of 7%. That's pretty robust and was driven by the price increases that the company has been pushing through to consumers to deal with the inflation headwinds it is facing. Essentially, P&G's costs are going up, so it is charging more for its products, which is par for the course in the consumer staples space during periods like this. Basically, all of the company's peers are doing the exact same thing.
P&G has been doing particularly well in its effort to pass on costs, with a full-year fiscal 2022 organic sales gain of 7% as well. However, there was a material shift between fiscal Q3 and fiscal Q4. In the third quarter, the company was able to push through higher costs throughout its brand portfolio and get consumers to shift to higher-priced items while also seeing higher volume. That's pretty much a dream scenario for a company like P&G.
In the fiscal fourth quarter, however, the company raised prices but consumers did not move toward higher-price items. And, notably, volume fell one percentage point. In P&G's beauty business, consumers actually shifted toward less expensive items.
An important pivot
So given the volume decline and the hints that consumers are looking for cheaper options, it looks as if Procter & Gamble has pushed as hard as it can on the price front. Inflation is still quite high relative to recent history, so the company may have to start absorbing more of the cost impact. That, in turn, could result in weaker profit margin until either inflation abates or the company can push through more price hikes without materially upending its business. The other choice is to keep pushing price increases while accepting volume losses. That's not an unreasonable approach, but losing too much volume, which could also mean giving up market share, is also a big negative.
At present, management is guiding for fiscal 2023 organic sales growth between 3% and 5%, down notably from 7% in fiscal 2022. During the conference call, the company's CFO noted that it would be "naive" to assume that consumers aren't closely watching their spending. While consumers have so far been willing to pay more for products than historical trends would suggest, P&G is expecting elasticities (industry jargon for the willingness of consumers to pay more) to return to more normal levels.
To be fair, 3% to 5% organic sales growth is not bad. However, it still needs to be taken with a grain of salt because Procter & Gamble tends to operate at the higher end of the categories it serves. Management will tell you that it differentiates itself by offering better products, but selling more expensive goods also means that in really tough times, there's more risk of consumers trading down to save money. If there's a sudden shift in the economic fortunes of its customers, the company may not be able to achieve its goals.
Investors need to keep a close eye on P&G's organic sales results going forward, paying particular attention to the interplay between price hikes, volume, and sales mix (essentially, the shift toward higher- or lower-priced items in the company's own brand portfolio).
Still a great company
Dividend King Procter & Gamble isn't suddenly going to become a bad company because of these headwinds. However, it could go through a period when performance doesn't live up to the company's recent success. That's worth watching so you aren't surprised when the sine curve of business life inevitably turns lower. That, however, may actually provide long-term dividend investors with an opportunity to buy the stock at a discounted price if the shares trade materially lower.
However, there's still one more lesson here. If a company that has been excelling in the consumer products space is suddenly talking about weakness ahead, then the entire sector is probably starting to see a shift. If you own weaker-positioned consumer staples names, you might want to prepare yourself now for increasingly tough sales numbers.