Interactive Investor

Why I’ve downgraded this Dow Jones megastar

25th January 2023 08:36

Rodney Hobson from interactive investor

It pays a decent dividend but this colossal multinational has put off overseas investing expert Rodney Hobson. Here’s why he’s cut his rating on the shares.

Tougher times for consumers has translated into a squeeze on Procter & Gamble Co (NYSE:PG). The strength of the US dollar has not helped, either. Increasing profits in the near term is going to be difficult.

The consumer goods firm, whose brands include Aerial, Fairy, Gillette and Lenor, reported that net sales fell 1% to $20.8 billion in the final three months of 2022, the second quarter of its financial year. Beauty, grooming, baby, feminine and family care all saw falls in sales, while healthcare did best, although even here growth was only 2%.

Admittedly, the figures are not quite as bad as they seem. Just over half of all revenue comes from outside the United States, and the strength of the dollar cut the value of sales made in other currencies, otherwise there would have been 5% growth. The company is now slightly more optimistic about keeping up that level of growth for its full financial year to the end of June.

More worrying is that earnings per share (EPS) slipped from $1.66 in the same quarter of 2021 to $1.59. Chairman John Moeller expects EPS to grow over for the full year, but one might be more confident if he refrained from comments such as this: “We remain committed to our integrated strategies of a focused product portfolio, superiority, productivity, constructive disruption and an agile and accountable organization structure.”

Does that mindless jargon really add anything to the sum of human knowledge? Or increase confidence that he has a grip on the company’s operations? Despite the bullish tone, P&G’s sales comparisons have actually slipped back since the previous quarter.

The company certainly needs to concentrate meaningfully on higher input costs and increased distribution charges. While the range of strong brand names such as Tide washing powder, Oral-B toothbrushes, Pentene shampoo and Pampers nappies has allowed P&G to pass increased costs on to consumers in the form of higher prices, there is a worrying trend for hard-pressed consumer to switch to cheaper own-brand alternatives in supermarkets.

This could be the point at which P&G discovers that its pricing power is not as strong as it thought. It has raised prices by 5% but seen sales drop 6% in volume terms. If consumers find that cheaper alternatives are just as good, or so close that they cannot tell the difference, then those customers are potentially lost forever.

Gross profit margins did pick up in the latest period but at 47.4% are still lower than they were a year earlier. To restore margins, P&G will need to raise selling prices further while hoping that the rise in input prices is abating.

Source:  interactive investor. Past performance is not a guide to future performance.

The shares have bounced around quite a bit over the past 12 months, dropping from over $160 to a low of $123 in October, and are now somewhere in the middle of that range at $142, where the price/earnings ratio is a quite demanding 25. P&G has paid a dividend every year since it started up 130 years ago and the yield is a reasonable, if not overwhelming, 2.6%.

Hobson’s choice: The strength of P&G’s brands has prompted me to tip the shares in the past, and anyone following that advice has enjoyed a decent dividend to compensate for the effect that ups and downs in the share price may have had on their nerves.

Figures from the past two quarters have made me a lot more cautious. If you are already in, you should hold on and await the better times that will no doubt come eventually, but anyone thinking of buying should wait to see if a better opportunity arises. It is quite possible the shares will drop back to $123 again while investors wait for improved news.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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