Proctor & Gamble (PG) reported fiscal second-quarter results Friday that were weighed down by higher commodity costs. The company reduced its 2012 outlook due to non-operating items (currency, taxes), but we think there may be more to the revision than management is leading investors to believe. Nonetheless, we are maintaining our fair value estimate range, which we think adequately captures such risks, and continue to hold the company in the portfolio of our Dividend Growth Newsletter.
P&G’s revenue advanced 4% in its fiscal second quarter—all of it organic—thanks to growth in all six of the firm’s business segments. Volume contributed one percentage point to the increase, while broad-based price increases accounted for the balance. The firm’s core operating margin fell 160 basis points due to rising commodity costs, which more than offset the company’s pricing actions. We’re not pleased that P&G is unable to raise prices at a pace that is sufficient to mitigate rising input costs and view this as poor execution by management given the company’s solid brands (Pampers, Tide, Always, Pantene, Bounty, Dawn, Charmin, Head & Shoulders, Gillette, Febreze, etc.).
Adjusted diluted earnings per share came in at $1.10 (versus consensus expectations of $1.08), reaching the high end of management’s guidance range but falling 3% from the same period a year ago. The firm’s operating cash flow was $3.3 billion in the quarter and free cash flow came in at $2.4 billion, about 10.9% of sales. P&G continues to be a veritable cash cow and has significant dividend coverage with cash flow.
Looking ahead, management noted that it expects commodity costs to ease in the back half of its fiscal year, which should translate into improved bottom-line expansion. For all of 2012, P&G expects net sales to advance 3% to 4%, with organic sales to comprise all of the expansion, offset in part by negative currency impacts. However, the company reduced its core diluted earnings per share guidance to the range of $4 to $4.10 from the range of $4.15 to $4.33 (consensus expectations were $4.17 per share). Management indicated that the primary factors behind the revision were negative foreign exchange and a higher tax rate (non-operating items). However, given P&G’s strong brands, we think the disappointing guidance adjustment has more to do with lack of execution by management with its pricing initiatives than the non-operating items listed.
Though we’re disappointed with the company’s muted outlook, we continue to be impressed with P&G’s cash-flow generating prowess. The firm remains a solid holding in the portfolio of our Dividend Growth Newsletter, and we expect a dividend increase from the firm this year.