P&G Sets Stage for Improved Long-Term Results

After closing the book on a significant brand rationalization, cutting 100 brands from its mix--leaving it with 65 brands--

We surmise the benefit of this focus is starting to surface, as evidenced by the 2% organic sales growth (which came in the face of intense competition), driven by higher volumes. But importantly, this growth was a sequential improvement from a 1% increase last quarter and came on top of similar growth a year ago.

Rather than exclusively focusing on sales gains, we believe P&G is looking to drive sustainable and profitable growth, which we view as prudent. In this vein, P&G has embarked on an effort to extract another $10 billion from its operations (targeting to reduce overhead, lower material costs, and increase manufacturing and marketing productivity).

This initiative is already beginning to yield traction, as adjusted operating margins ticked up 210 basis points to 19.1%, despite a 10-basis-point decline in adjusted gross margins to 49.3% (reflecting a 120-basis-point hit from commodity cost inflation and a 90-basis-point impact from unfavorable mix).

In our view, however, P&G is unlikely to let the entirety of these savings fall to the bottom line; instead, we expect these funds will fuel brand investment to prop up sales and support the intangible assets (entrenched retail relationships and leading brands) that underlie our wide moat rating.

We don’t foresee a material change to our $94 fair value estimate or long-term forecast, which calls for operating margins to expand more than 300 basis points to nearly 25% by 2026, along with 4% long-term annual sales growth. Despite the modest uptick, shares still trade a touch below our valuation, and we’d suggest investors keep an eye on this name.

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