P&G Weathers COVID-19, but a Storm Still Lies Ahead

Despite the tailwind from consumers’ recent pantry loading of essential fare--like that in Procter & Gamble’s PG mix--as social distancing has taken hold, we view the wide-moat company's third-quarter results as solid. Organic sales popped 6% (on top of 5% growth in the year-ago period, primarily resulting from higher volume), adjusted gross margins edged up 120 basis points to 50.4% (as productivity savings and lower commodity costs offset the impact from unfavorable mix), and adjusted operating margins expanded 100 basis points to 20.9% (even with a 190-basis-point headwind from increased marketing spending). We attribute this performance partly to the revamped strategic playbook P&G has operated under the last few years, centered on driving efficiency savings and funneling additional resources behind its core brands after materially rationalizing its portfolio during 2014-16.

Management said it's operating under the presumption that the economy has already turned recessionary and is bound to get materially worse as unemployment rates stand to surge, with the prime point of uncertainty being how long this situation persists. However, with just three months left in its fiscal year, P&G held the line on its full-year outlook for 4%-5% and 8%-11% organic sales and adjusted EPS growth, respectively. With results tracking our forecast, we don’t expect to alter our $109 fair value estimate or long-term outlook, which is based on nearly 4% annual sales growth and a 300-basis-point bump in operating margins relative to fiscal 2019 to more than 24% by fiscal 2029.

The stock failed to budge on the print, but it still trades at about the same level it started the year, compared with a low-double-digit pullback in the Morningstar U.S. Large Cap Market Index. While P&G’s stalwart competitive edge should position the company well to withstand the competitive and macro headwinds, we think investors should await a more attractive risk/return opportunity.

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