P&G's Hot Growth: Cooler Times Ahead?


By Robert Berner Continuing to far outperform the rest of the consumer-products industry, Procter & Gamble (PG) on Oct. 27 reported a 14% increase in fiscal first-quarter profits on strong sales growth across most its businesses. But Wall Street and some analysts are starting to question how long P&G can maintain its superior momentum in the face of stepped-up competition from rivals and rising commodity costs.

The world's largest consumer-product company said net income for the quarter ended Sept. 30 totaled $2 billion, or 73 cents a share. That compares to $1.76 billion, or 63 cents a share, for the same period a year ago. P&G was expected to earn 72 cents a share for the quarter, according to a consensus of analysts' estimates by Thomson First Call. Net sales rose 13%, to $13.74 billion, from $12.20 billion a year ago. Unit volume, excluding acquisitions, rose 8% during the quarter, a rate of growth that's nearly double the industry average.

HIGHER COSTS. Indeed, the results offered little to complain about at face value. P&G said it saw growth in all of its geographic regions, led by developing markets. Four of its five business divisions posted profit increases, led by health care, with a 23% gain. The only laggard was the snacks and coffee division, where profits fell 13% due to higher coffee costs and increased spending behind its snack business.

The results, however, come amid a spate of weak earnings by competitors, such as Colgate-Palmolive (CL) and Unilever (UL). They've ratcheted down expectations, saying they need to spend more behind their brands to drive sales growth as they struggle with higher raw material costs.

Part of their problem has clearly been P&G, which has done a better job in recent years of launching successful new products. But with more competitors willing to sacrifice earnings growth to boost sales and market share, investors are rightly concerned about how long P&G can continue to hit its target of double-digit earnings growth, says Banc of America analyst William Steele. While he's sticking with his forecast that P&G will earn $2.60 a share for its fiscal year ending this June, "it's not a slam dunk," he says.

FALLING MARGINS. In fact, one number in P&G's quarterly results added more weight to that concern. While gross profit margin as a percent of sales rose due a shift to higher-priced businesses such as beauty care and improved manufacturing efficiencies, P&G's operating margin declined. It fell 0.8 percentage points, to 20.9% of sales, reflecting increased marketing costs, Steele says.

P&G's strong growth in developing markets also carries risk, notes Deutsche Bank's Schmitz. Products in those countries are usually sold at lower prices, which could squeeze margins if P&G doesn't get the volume gains it expects, he notes. And competitors are certainly stepping up efforts abroad as well.

So far, P&G's four-year turnaround has shown no sign of losing steam. But that's not stopping the doubts from creeping up. Berner is a correspondent in BusinessWeek's Chicago bureau


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