Procter & Gamble (PG -0.78%) is one of the largest consumer staples producers on the planet, making it an important company to watch in the industry. Normally a pretty boring sector, the last couple of years have been exciting, but not in a good way. Inflation pushed margins lower, causing P&G and its peers to raise prices. The dynamics are starting to change, but this industry bellwether is warning that there are still problems to deal with.
An exaggeration of the normal ups and downs
There's a typical cycle in the consumer staples space. As a company faces rising costs for ingredients, packaging, transportation, and salaries, it cuts costs, changes packaging architecture (for example, putting less product in a box), and raises prices. Normally these things are rolled out slowly over time because inflation tends to be slow moving.
Image source: Getty Images.
Things were different in 2021 and 2022, with the upheaval from the coronavirus pandemic, and the response to it, creating a shockingly swift increase in inflation. The cost headwinds were so severe and so rapid that companies like Procter & Gamble instituted multiple rounds of price increases in a very short period of time. The industry does not like doing that. Some companies were more successful than others in this effort, with P&G faring particularly well.
To put a number on that, the company's organic sales growth has been at 5% or higher in each of the last five fiscal years despite the price hikes it pushed through over the last year or so. Although 5% might not sound huge, it is a strong number for a consumer staples maker. To be fair, volume declined 3 percentage points in fiscal 2023, but price hikes and product mix more than offset the decline to leave P&G with a 7% organic sales increase. Some companies have not been so lucky.
Things are getting better-ish
As Procter & Gamble laid out its fiscal 2024 outlook, it presented an interesting view of the landscape. Over the past year or so, key ingredient costs have been a major headwind. But many of these items are commodities, so the prices rise and fall over time. In fiscal 2024, management expects commodity pressure to turn around and become a tailwind to the tune of $800 million. That's a breath of fresh air after the last couple of years.
And yet there's some caveats here. For example, the company doesn't expect to see a material benefit from this tailwind until the fiscal second half. It has contracts that have to roll over before it will benefit from lower prices. So there's good news on the commodity front, but it isn't going to show up immediately.
There's also the issue of employee costs, which aren't going to go away. When a salary gets increased, it doesn't go back down (unless the company reduces headcount). This is an issue that impacts P&G both directly and indirectly. While commodity prices might have stabilized, or even declined in some cases, the company's suppliers are also facing rising employee costs. Just like P&G has been trying to protect its margins, its suppliers are trying to protect theirs. When contracts with suppliers roll over, there are likely to be higher costs that will have to be absorbed by P&G.
It's always a complex dance. Just this time around, both the size and speed of the change has been a bit mind-boggling. What might have played out over several years was compressed into just 12 to 18 months or so. The situation is starting to normalize, but P&G still wants investors to understand it is not yet fully back to normal.
Watch for a turn, but don't expect too much
At the end of the day, P&G is telling shareholders to expect the inflation situation to get better as fiscal 2024 unfolds. But at the same time, it is warning investors not to get too excited.
The situation is improving, but there's still more that needs to be done before the inflation headwinds fully abate and business can get back to some semblance of normal. That's something you might want to keep in mind for the entire consumer staples sector. This bout of inflation has been just a little more complex than usual.
