P&G Continues to Chalk Up Modest Sales Gains

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We’ve long maintained that focusing its resources (personnel and financial) on the highest-return opportunities should position P&G for accelerating sales, and recent results provide credence to our stance.

The firm isn’t looking merely to drive unsustainable sales gains, but is working to root out inefficiencies, targeting to extract another $10 billion of costs by reducing overhead, lowering material costs, and increasing manufacturing and marketing productivity. And in that vein, adjusted gross margins ticked up 70 basis points to 51.5%, but adjusted operating margins held constant at 23.5%, as P&G has opted to reinvest in its brands and further entrench its business with retailers, supporting its intangible asset moat source.

Partly as a result of its efforts to eliminate costs, we forecast gross margins will expand by around 200 basis points over the next 10 years to 51%, about 200 basis points above its average gross margin over the past five years. However, we also expect P&G will allocate 3% of sales for research and development and 11.5% of sales for marketing annually, up from historical levels of less than 3% and around 11%, respectively.

We don’t expect to alter our $92 fair value estimate, and haven’t wavered on our long-term discounted cash flow expectations--annual top-line growth about 4% over the next 10 years and 24%-plus operating margins (from 21% in 2016). Following a mid-single-digit rise in the shares, the discount relative to our valuation is contracting. However, we still suggest investors interested in the space keep an eye on this wide-moat name.

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