As another fascinating earnings season looms, investors have marked their calendars for the unmissable event of The Procter & Gamble Company (NYSE: PG) releasing quarterly earnings on the back of another challenging set of headwinds faced in recent months. Delving into the world of detergent dominance and shampoo supremacy, will they cleanse their portfolio from investor uncertainty?
In the third quarter of 2023, the company generated earnings per share (EPS) of $1.37 on revenue of $20.1Bn, showcasing growth of 3% and 4%, respectively. CEO Jon Moeller cited a problematic cost environment, with inflationary pressures putting upward pressure on input costs. However, with its strong presence in the industry and well-renowned brand portfolio, Procter & Gamble continues to deliver growth and value to their shareholders, with traders betting on a similar trend for the upcoming quarter.
Technical
On the 1D chart, a symmetrical triangle has formed, leaving the possibility for a directional breakout in either direction, with the price action close to the 50-day moving average of $149.94 and daily pivot point of $148.03. With technical indicators relatively neutral, the earnings release could be instrumental for the forward-looking trend.
If the bears enforce a breakdown at the triangle support, the market could push down toward $145.94 (S2). Further downside pressure could confirm the sustainability of the breakdown, where support is established at $143.49 and $141.18.
However, on a discounted cash flow basis, the company’s estimated fair value is $159.89. While this presents a 7.29% potential upside from current levels in the case of an upside triangle breakout, the possible bearish moves could widen the potential discrepancy between price and value. In the path to convergence, resistance at $152.54, $154.37, and $157.15 could be potential hurdles to cross in the longer-term play.
Fundamental
Despite the challenging macroeconomic landscape in recent months, the market has favoured a shift to growth at the expense of value. The trend can be seen below, with a clear divergence in the growth of IVW (Growth ETF) and IVE (Value ETF). However, it is even more alarming considering the underperformance of Procter & Gamble and its competitors compared to the value ETF on a year-to-date basis. The consumer staples sector, in general, has been under strain, returning -1.11% YTD, while Procter & Gamble lagged behind with -1.79%. Perhaps the benefit of dividend payments and income growth has become less attractive in the high-interest rate environment. Nevertheless, an optimistic earnings release could potentially open up a lucrative opportunity at lower valuations.
Procter & Gamble has been consistent in their top-line expansion, with the recent quarter being no exception. Net Sales grew 4% to $20.1Bn, reflecting 7% organic sales growth. However, when delving deeper, the sustainability of this expansion is concerning. Currently, the majority of their growth relies on price increases. In the latest quarter, 10% growth was attributed to price increases, while volume contracted by 3%, along with a 4% reduction from foreign exchange movements. While their strong brand loyalty possesses them with the pricing power necessary to continue top-line expansion in this manner, it becomes worrying when considering the global economy might go into recession in later quarters this year.
The lower sales volume exaggerates the efficiency problem that the company currently battles with. The graph below demonstrates the inventory turnover and days outstanding inventory over the last five years. A clear trend is evident, with inventory turnover significantly down while days outstanding inventory continues to rise. With an unfavourable inventory-to-sales ratio, the company may need to lower its prices to eliminate excess inventory, but as previously mentioned, higher pricing is the primary driver of their top-line expansion. Therefore, investors may want to see higher volumes and a more sustainable sales breakdown in the upcoming quarter. A possible tailwind in this regard is the recent slowdown in US inflation from 4% to 3%, with the Federal Reserve signalling a potential end to the rate hike cycle. Not only could this aid the company in shifting away from price increases towards volume as a means of generating top-line growth, but the contraction in the US dollar could provide a foreign exchange tailwind in upcoming quarters.
Unsurprisingly, the company’s margins have been under pressure due to the rising input costs. However, they still operate with the highest net income margin (16.93%) and EBIT Margin (21.6%) in comparison to industry peers, while their gross profit margin (48.16%) is not lagging far behind. Additionally, the company continuously innovates and embraces automation to ensure a more efficient supply chain. By aiming to implement fully automated quality control systems and using artificial intelligence to connect retailers and suppliers more seamlessly, the company is investing in cost-saving initiatives that could inflate margins as we advance.
Not only does that create a favourable cost environment, but the company’s balance sheet is also worth mentioning. Compared to the consumer staple players on the S&P 500, Procter & Gamble looks well positioned regarding its debt to operating cash flow metrics. While generating the second-highest cash from operations, they sit far lower down the list in terms of long-term debt. With lower leverage, the company is well-poised to use its ample cash flow base to invest in the efficiency measures mentioned above without risking its dividend payouts to shareholders.
However, with their economic moat, the company operates at higher relative valuation multiples. With a P/S ratio of 4.3X, they are the most expensive relative to the amount of sales they generate, while their P/FCF ratio of 28.8X makes them the joint most expensive in the industry on a free cash flow basis. It is up to the investor’s discretion whether these higher valuations are justified by their competitive advantages within the industry.
Summary
As we head into a highly anticipated earnings season, Procter & Gamble will be hoping for an optimistic release to spark some momentum into their stagnating share price. One of the main focal points of the release could be clarity on their ability to expand their top line through volume growth rather than unsustainable price rises as the macroeconomic environment reaches a potential inflexion point. With the estimated fair value at $159.89, this retail giant presents a 7.29% potential upside for the bullish investor who is optimistic about their prospects going forward.
Sources: Koyfin, Tradingview, Yahoo Finance, Reuters, The Procter & Gamble Company.
