Consumer Remains the Wild Card for PG

For Gilmartin's preview heading into the Procter & Gamble conference call, please click here.

Procter & Gamble (PG - commentary - Cramer's Take) reported first-quarter 2009 earnings this morning, printing $1.03 in EPS and $22.026 billion in revenue vs. consensus estimates 98 cents in EPS and $21.87 billion in revenue, for year-over-year growth of 14% and 9%, respectively.

Organic revenue grew by 5%, and, more importantly, organic volume grew by 2%, the lowest organic volume growth in some time.

In our preview, we highlighted the three C's -- namely, currency, commodity price pressures and the consumer -- and all played a significant role in the quarter. The currency tailwind of the last three years will now become a headwind, although the 5% organic revenue growth was very consistent with the last three years' quarterly data. The commodity price pressure headwind will now start to see some relief through the remainder of fiscal 2009. Finally, the consumer was an issue as Procter & Gamble saw some trading down to private-label products.

Positives in the quarter:

• SG&A leverage helped the EPS beat, even though Procter & Gamble had an effective tax rate of 40%, slightly higher than normal. To offset commodity margin pressure, the company has reduced SG&A to an annual run rate of 3%, lower than the "normalized" 6% to 7% in past years.
• Organic revenue growth is still in the mid single digits, which is very stable and consistent.
• Price increases of 3% were pushed through in the first quarter.
• With the company sporting a 9% to 10% free cash flow yield, cash flow generation is robust and very consistent.
• Commodity cost pressure should continue to decline in fiscal 2009, resulting in stable gross and operating margins.

Negatives in the quarter:

• Procter & Gamble is a pricey brand, and the consumer did trade down to some lower-cost private-label products. Organic volume of growth of 2% was the lowest in years and might make price increases harder to come by in 2009.
• Management guided to 2% to 3% organic volume growth in fiscal 2009, lower than the long-run average.
• The currency tailwind boosting revenue by 5% in the last few years will now be a headwind of 2% to 3% in the coming quarters.
• Second-quarter 2009 guidance was a little weaker than the current consensus, with EPS projected to be $1.00 (excluding the Folger's spinoff), but this could also be the typical Procter & Gamble conservatism.

Currently trading at 15 times 2009 earnings and 14 times 2010 earnings, Procter & Gamble has always had a little bit of a growth premium built into the stock, given the consistency and dependability of earnings. I would expect earnings estimates to be revised slightly lower for 2009 and 2010 after this quarter, given the low organic volume growth and consumer worries.

To conclude, Procter & Gamble has always been perceived as a defensive stock, with mid-single-digit organic revenue growth and low-double-digit earnings growth, benefitting from SG&A leverage, and this quarter was no different. As currency tailwinds become a headwind, the commodity headwind will now become a tailwind, with the consumer as the wild card. Still, given the brand power of the majority of its products and the consistent and stable cash-flow generation, over the long run Procter & Gamble is a consistent value generator for investors. The company has a large amount of debt maturing over the next year, although, with its balance sheet and cash flow generation, this really isn't an issue.

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At the time of publication, Gilmartin was long Procter & Gamble, although positions may change at any time.

Brian Gilmartin, CFA, founded Trinity Asset Management (TAM) in 1995, where he is currently a portfolio manager. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gilmartin appreciates your feedback; click here to send him an email.