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PROCTER & GAMBLE Co (PG) Q1 2016 Earnings Summary

Executive Summary

  • Q1 FY2016 delivered strong profitability despite top-line softness: net sales $16.53B (-12% YoY; FX -9 pts; Venezuela/divestitures -2 pts), organic sales -1%, Core EPS $0.98 (-1%), with currency-neutral Core EPS up 12% and core operating margin up 270 bps.
  • Reported gross margin rose 260 bps to 50.7% and operating margin 340 bps to 22.8%, fueled by ~260 bps productivity savings; adjusted free cash flow productivity was 101%.
  • Guidance largely maintained: organic sales in-line to up low single digits; all-in sales now expected down high single digits (worse due to FX 5–6 pts and 2–3 pts from Venezuela/divestitures); Core EPS slightly below to up mid-single digits; GAAP EPS up 53–63%.
  • Management expects a return to positive organic growth in Q2 and strengthening in the back half, with targeted investments in sampling/trial and premium innovations (notably in Fabric Care, Baby Care, China).
  • Capital return continued: ~$0.5B buybacks and $1.9B dividends in Q1; plan to retire $8–9B in shares in FY2016 (incl. Duracell exchange) and pay >$7B in dividends.

What Went Well and What Went Wrong

What Went Well

  • Margin expansion: core gross margin +250 bps and core operating margin +270 bps; management highlighted ~260 bps productivity savings driving core OI and ~170 bps within gross margin. “We delivered strong first quarter operating profit margin and free cash flow results.”
  • Productivity and cash flow: operating cash flow $3.54B; free cash flow $3.01B; adjusted FCF productivity 101%.
  • Strategic focus and early progress: U.S. Fabric Care and Baby Care showed improving shares; conviction Q2 organic sales will be positive and strengthen thereafter. “We expect second quarter organic sales growth to be positive and to further strengthen in the back half...”

What Went Wrong

  • Top-line softness and volume: organic sales -1% as pricing (+2 pts) and mix (+1 pt) were offset by organic volume -4%; all-in sales -12% on FX and portfolio actions.
  • Emerging markets and China: China organic sales down ~8%, Brazil volatile (down ~12% in quarter after +7% prior), soft volumes in Baby Care outside U.S., competitive intensity.
  • FX headwinds and pricing trade-offs: stronger USD vs euro/yen competitors drove pricing actions (e.g., Russia), impacting volumes; management rolled back some price increases where necessary to maintain sustainable value.

Financial Results

MetricQ3 FY2015Q4 FY2015Q1 FY2016
Net Sales ($USD Billions)$18.142 $17.790 $16.527
Organic Sales Growth (% YoY)+1% 0% -1%
Diluted EPS - Continuing Operations ($)$0.85 $0.22 $0.96
Diluted Net EPS ($)$0.75 $0.18 $0.91
Core EPS ($)$0.92 $1.00 $0.98
Gross Margin (%) (GAAP)48.6% 48.0% 50.7%
Core Gross Margin (%)49.5% 49.1% 51.1%
Operating Margin (%) (GAAP)17.3% 5.2% 22.8%
Core Operating Margin (%)18.7% 18.1% 23.2%
Effective Tax Rate (%)19.6% 49.6% 24.0%
Consensus EPS ($)Unavailable*Unavailable*Unavailable*
Consensus Revenue ($B)Unavailable*Unavailable*Unavailable*

*Estimates via S&P Global were unavailable due to system limit; values not retrieved.

Segment Breakdown (Q1 FY2016)

SegmentNet Sales ($USD Millions)YoY Net Sales %Net Earnings from Continuing Ops ($USD Millions)YoY Net Earnings %
Beauty$3,041 (12)% $624 (2)%
Grooming$1,674 (14)% $390 (16)%
Health Care$1,796 (11)% $318 (1)%
Fabric Care & Home Care$5,251 (11)% $747 +4%
Baby, Feminine & Family Care$4,658 (12)% $749 (9)%
Corporate$107 (12)% $(51) N/A
Total Company$16,527 (12)% $2,777 +2%

Organic Sales Growth by Segment (Q1 FY2016)

SegmentOrganic Sales Growth (% YoY)
Beauty(2)%
Grooming0%
Health Care(1)%
Fabric Care & Home Care0%
Baby, Feminine & Family Care(3)%
Total P&G(1)%

KPIs (Q1 FY2016)

KPIValue
Operating Cash Flow$3.538B
Capital Expenditures$0.532B
Free Cash Flow$3.006B
Adjusted FCF Productivity101%
Share Repurchases$0.5B
Dividends Paid$1.9B
Cash & Equivalents (End of Period)$7.705B

Guidance Changes

MetricPeriodPrevious GuidanceCurrent GuidanceChange
Organic Sales GrowthFY2016In-line to up low single digits In-line to up low single digits Maintained
All-in Sales GrowthFY2016Down low-to-mid single digits; FX ~4–5 pts headwind Down high single digits; FX ~5–6 pts headwind; +2–3 pts drag from Venezuela/deconsolidation & minor divestitures Lowered all-in sales; FX headwind worsened; explicit deconsolidation impact
Core EPS Growth vs $3.76 (restated)FY2016Slightly below to up mid-single digits Slightly below to up mid-single digits Maintained
GAAP EPS GrowthFY2016+53% to +63% +53% to +63% Maintained
Core Operating Income GrowthFY2016Strong (improvement expected) Continues to expect strong core OP growth Maintained
Core Effective Tax RateFY2016Not previously specified~24% Clarified
Share RetirementsFY2016Not specifiedRetire ~$8–9B via repurchase/exchange (incl. Duracell); Dividends >$7B New detail

Earnings Call Themes & Trends

TopicQ3 FY2015 (prior)Q4 FY2015 (prior)Q1 FY2016 (current)Trend
FX and PricingFX -8 pts; plan to offset via pricing/mix/cost; core EPS +10% cc FX headwind to FY2016 all-in sales ~5%; Venezuela deconsolidation planned FX headwind now 5–6 pts; pragmatic pricing (e.g., Russia) with some rollbacks; focus on sustainable value FX pressure intensifying; pricing actions becoming more surgical
Productivity>400 bps savings driving margin expansion FY2015 COGS savings >$7B; ongoing productivity plan ~260 bps productivity drove core OI; further savings expected; build through year Sustained, key lever for margins
Emerging MarketsMixed: EM growth pockets; competitive activity in Hair Care Venezuela deconsolidation; portfolio reshaping China -8% organic; Brazil volatile; portfolio cleanup impacting developing markets; plan to compete in premium tiers Near-term drag; focus on premium innovation
Supply ChainMajor initiatives to localize manufacturing, reduce costs Resiting plants; multi-category facilities Ongoing localization/automation; supports margin and FX mitigation Execution continues
Marketing & TrialAgency/production cuts; reinvesting in working media —Increase working marketing spend and sampling at points of market entry/change; avoid unsustainable promotions Shift to targeted trial/support
Portfolio ActionsDuracell to be exchanged; Beauty exits planned Clarified restatement; exits continuing Ongoing cleanup (Mexico tissue; Fabric Care de-prioritization) to improve profitability Profitability over low-quality sales

Management Commentary

  • “We delivered strong first quarter operating profit margin and free cash flow results… We expect second quarter organic sales growth to be positive and to further strengthen in the back half…” — A.G. Lafley (Chairman & CEO)
  • “Adjusted free cash flow productivity was very strong at 101%… Constant currency core EPS increased double digits, with meaningful triple-digit basis point improvements in both gross and operating margins.” — Jon R. Moeller (CFO)
  • “We are deprioritizing less profitable… brands and product lines… improving the profitability… even when these choices create short-term top line pressure.” — Jon R. Moeller
  • “We will not… be looking to promotion as a way to strengthen our business… We’d much prefer to establish superior value equations with superior products that are adequately supported.” — Jon R. Moeller

Q&A Highlights

  • EM segmentation and China: China down 8% organic; absence in premium tiers hurt; premium taped/pants diapers and compact liquids launching; Brazil volatile; Russia +2% organic despite macro; underlying top-line running ~+1% after cleanup and one-time constraints.
  • Pricing vs competition: Stronger USD creates need for pragmatic pricing; some rollbacks (Russia); recovery via mix and cost savings; avoid unsustainable price levels.
  • Margin sustainability: Gross margin expansion driven by ~170 bps savings, ~80 bps pricing, ~110 bps commodities; productivity expected to continue, commodities/pricing annualize.
  • Guidance clarity: All-in sales lowered primarily on FX; EPS range retained amid volatility; focus on right choices over frequent guidance updates.
  • Capital allocation: ~$0.5B repurchase in Q1; plan to retire $8–9B shares (incl. Duracell) and pay >$7B dividends; repurchases to increase as year progresses.

Estimates Context

  • S&P Global consensus estimates for revenue/EPS were unavailable for Q3 FY2015, Q4 FY2015, and Q1 FY2016 due to system limits; therefore, beat/miss vs Street cannot be assessed here. Management emphasized currency-neutral Core EPS growth (+12% in Q1) and strong margin expansion, which may imply upward revisions to margin expectations, while FX and EM dynamics could temper top-line estimates.

Key Takeaways for Investors

  • Margin story intact: core gross +250 bps and core operating +270 bps reflect durable productivity; watch for continued savings cadence as a support for EPS amidst FX.
  • Top-line inflection ahead: management targets a return to positive organic growth in Q2 with stronger H2 on innovation and trial; monitor progress in U.S. Fabric/Baby and China premium launches.
  • Pricing discipline: expect targeted value equation adjustments where needed (e.g., Russia), with preference for innovation-driven mix over promotions; volume recovery should lag sales.
  • EM risk/reward: China/Brazil volatility and portfolio cleanup weigh near term; successful premium execution is key to re-accelerate EM contributions and reduce negative mix.
  • Capital returns supportive: buybacks and dividends remain robust (~$15–16B planned via exchanges/repurchase/dividends in FY2016); Duracell exchange provides significant share retirement catalyst.
  • Guidance posture: all-in sales lowered on FX/deconsolidation; Core EPS range maintained; focus is on long-term value creation over near-term top-line at any cost.
  • Trading implications: near-term catalysts include Q2 organic growth resumption and confirmation of margin sustainability; medium-term thesis hinges on premium innovation uptake (China/U.S.), continued productivity delivery, and disciplined capital allocation.

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