Consumer-staples titan Procter & Gamble (PG 1.11%) releases its second-quarter fiscal 2014 earnings on Friday. Two years into a $10 billion restructuring that will run through 2016, the company is attempting to invigorate revenue growth, while continuing the product innovation for which it is known. Following are themes that investors will want to drill down on in both the upcoming earnings release and subsequent conference call with analysts.
Continued membership in "The 4% Club"
As I've argued recently, some of the world's most influential consumer-goods companies will be faced with a difficult near-term revenue growth environment in 2014, as emerging markets can't be counted on to provide them the same sales octane boost as in the last couple of years. P&G is projecting full-year organic revenue growth of 3%-4%in fiscal 2014, which places it firmly in the same revenue growth club as peers Mondelez MDLZ 0.83% and Unilever (UL 1.70%).
A variance of more than 1% to the north or south of this range will bear some scrutiny: Hitting 6%, for example, will obviously count as welcome news, while an organic growth rate of just 1% over the prior-year quarter will place much pressure on P&G to perform in the final two quarters of the year. One inference can be drawn for certain: When the projected band of revenue growth is as tight as a one-percentage-point spread, little room for error in execution exists.
Impact of China
China's portion of P&G's revenue has grown in recent years and now accounts for more than $7 billion of the company's $84.2 billion annual revenue. Last quarter, however, the company recorded basically flat volume market share growth in China. Recent China performance is one of the key factors keeping P&G in the "4% Club" I mentioned. Without providing much in the way of specifics, management has stated that it is working on product innovations that are expected to improve market share in the back half of the year. Investors will look for evidence of renewed market share increases in China on Friday.
Gross margin
P&G's gross margins have weakened marginally in recent quarters because of a number of factors. In the company's last reported quarter, management cited higher commodity costs, foreign exchange headwinds, and "start-up manufacturing costs" as factors pushing margins down. The start-up manufacturing costs refer to the simultaneous start-ups of new manufacturing plants in emerging markets, including China, Brazil, Nigeria, and Indonesia. As these costs will continue during the current fiscal year, gross margin may remain soft and land somewhere below last year's average of 49.6%.
On the whole, taking incremental hits on gross margin should reap benefits for P&G in the future. Local manufacturing reduces the need to import the company's products into the various emerging markets in which it is trying to increase sales. Purchasing the inputs for production locally can insulate corporations from currency depreciation swings. Procter & Gamble has seen this firsthand recently, as depreciating currencies against the U.S. dollar in both Venezuela and Japan adversely affected revenues from those countries.
A business segment with breakout potential
The "Baby, Feminine, and Family Care" segment is one of the core outperformers for Procter & Gamble. This segment, which includes billion-dollar brands Bounty, Charmin, and Pampers, posted a year-over-year organic growth rate of 6% last quarter versus the prior year, and a 5% earnings improvement. The segment shows some similarities to Kimberly-Clark's (KMB 0.27%) overall business, which is poised through its concentration in feminine hygiene, baby wipes, diapers, and tissues to outperform over the next year. If recent trends hold, this business segment should post respectable results versus other segments, providing a rationale to focus additional resources in these staple goods.
Last April, The Wall Street Journal reported that P&G had begun to negotiate with some of its suppliers to extend payment terms from 45 days to roughly 75. The lengthened payment terms were projected to free up $2 billion in cash for P&G.
For years, the conglomerate has struggled to maintain proper working capital, as capital expenditures on new plants, dividend obligations to shareholders, and significant share repurchases have consumed operational cash. Lengthening accounts payable days outstanding (a measure of the time it takes to pay suppliers) will provide some flexibility on the balance sheet. These changes won't be reflected overnight: Net payables decreased from $8.8 billion to $7.5 billion during the last reported quarter, and accounts payable days outstanding likewise decreased from 70 days to 65.7 days.
Still, investors will want to watch the accounts-payable trends, and working capital in general. It would be refreshing and a pleasant surprise to see P&G retain a little more of its traditionally vigorous cash flow on its balance sheet this quarter.
Checking back in
While we're unlikely to hear of any substantive shifts in company strategy, the tea leaves at the bottom of Procter & Gamble's quarterly cup should provide some clarity on the company's prospects for revenue growth in fiscal 2014. We'll return to these themes and isolate other takeaways after earnings are released, so stay tuned.
