Proctor & Gamble Cuts Outlook: What Does It Mean?

Proctor & Gamble (PG), the worlds largest consumer product maker, cut their 2Q09 sales outlook, stating that they would not be able to reach their organic sales growth target, which excludes sales from acquisitions, of 4-6% due to the strengthening dollar and weakness due to private label brands. However, P&G did not cut their profit forecast for the quarter and confirmed their full year sales and profit guidance for 2009. This is largely due to the recent pullback in commodity prices, which has allowed for a lower cost of goods sold for the firm. Even though much of the effect was from the dollar, which is estimated to cause a 5% reduction in sales, it is still very disconcerting to see P&G, one of the most recession-resistant stocks, fall victim to the abysmal consumer spending environment. While Proctor & Gamble provides pretty inelastic goods, it has been the recent push for private label goods and movement into higher margin products that has hurt P&G.

Private Label

The trend toward private label goods, goods that are normally cheaper than the brand name products because they are produced by individual stores, has been one of the emerging trends in consumer staples over the past year. It seems as though consumers are even cutting back on the types of soaps, toothpaste, and shaving cream that they buy and going for the cheaper, private label brands instead of the brand names that P&G produces. Firms like Safeway (SWY) have greatly benefited from this trend as they have been able to draw in the consumer better than most firms. This is a trend that I would expect to continue in the future given that consumers are still deleveraging their balance sheets and trying to save more. They will cut costs anywhere they can over the next few months to years. This should hurt P&G because they tend to sell higher priced products in comparison to the private label brands.

Divestitures & Acquisitions

The acquisition of Gillette in 2005 and the recent sale of Folgers is probably part of the reason for the deterioration that P&G is seeing. Folgers was a lower margin, lower priced product, while Gillette products are the exact opposite, which has probably caused some problems in this tough environment. P&G’s decision to divest lower margin, lower priced brands and move into some more discretionary products by trying to expand their beauty and health care segments, has negatively impacted the bottom line in this economy. The company did state that they could attempt to make more acquisitions as value opens up in this environment. Do not be surprised to see P&G add to their already extremely diverse portfolio of goods.

The firm also stated that they would be spending more money to expand into emerging markets, such as India and China, as they try to continuously improve their global footprint. All this being said, P&G is still probably one of the better stocks to own in this environment because of the extreme volatility in the market, which Proctor & Gamble handles pretty well because of their strong business model, consistent earnings, and solid dividend.

This does help to point out some interesting trends in consumer staples though:

1. The recent reduction in commodity prices is positively impacting consumer staples’ companies cost of goods sold and could lead to margin expansion in the near future.
2. The trend towards private label goods is in full force due to the diminishing state of the consumer as they look to cut costs where ever they can, even if it means with soaps and toothpaste.
3. Currency is having a very big impact on many firms, particularly those that are not hedged or have hedged in the wrong direction. For example, Pepsico (PEP) has already stated that they will see about a 7% loss from currency hedging gone wrong, while Coca-Cola (KO) will see a gain from currency hedging. It is important to examine firms hedging strategies to ensure that they will not see extreme negative impacts to their bottom line in the future.

Disclosure: Author is long P&G and the mutual fund the author manages is long KO.

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