P&G Just Dropped A Consumer Staples Truth Bomb

A weak fourth-quarter earnings release sent shares of Procter & Gamble (NYSE: PG) tumbling 3% in the last week of January, and the stock has gone nowhere since the end of 2016. A competitive environment, eroding market share, and little pricing power have had investors questioning the safety of their money in the consumer staples giant.

The $226 billion consumer goods behemoth reported just 2% growth in sales from the same quarter last year, and that was entirely driven by volume with no pricing upside. Despite a cost-reduction plan that trimmed off 1.9%, the operating margin still lost 0.1% on a year-over-year basis.

Against this abysmal report by a bellwether of the sector, companies in the consumer products group still trade for a lofty 25.6 times trailing earnings. 

But not all was half-empty in the company’s earnings call. Looking deeper to the segment-level presented a different picture. 

#-ad_banner-#Using P&G as a guide for the larger sector may reveal opportunities for investors in consumer staples.

P&G Earnings As A Preview For The 2018 Consumer Staples
Procter & Gamble is so massive and so diversified across consumer-packaged products that it can be used as a guide to the sector. Even after culling 100 brands from its portfolio, the company still sells 65 brands across 10 product categories. 

Net sales of $65.1 billion in fiscal 2017 were mostly concentrated in North America (45% of total sales) and Europe (23%), though even smaller percentages from China (8%), Asia Pacific (9%), Latin America (8%) and EMEA (7%) produce billions in sales and act as a barometer for the regions.

The company separates results across five divisions (Beauty, Grooming, Health Care, Fabric & Home Care, Baby/Feminine & Family Care) and multiple product categories within each division.

While the overall results for the quarter gave investors good reason to rush to the exits, looking at segment-specific performance showed solid growth in some areas. Large conglomerated giants like P&G might continue to be weighed down by overall weakness but smaller, niche-focused companies may be able to take advantage of trends in the consumer sector.

P&G’s results also may point to the potential for increased M&A activity in the sector, aided by repatriated money by mega-cap companies. 

Some of the fastest-growing products for the company, including the Native deodorant brand and the SK-II luxury skin-care line, have been recent acquisitions. In fact, research by Boston Consulting Group shows that larger companies in the consumer goods space lost 3.2% of their market share to small- and mid-size companies over the five years through 2016. 

The need to protect market share and grow sales may spur an M&A boom in the space as large companies flush with cash target smaller brands.

Where Is The Growth In Consumer Products?
Beauty was the stand-out for the quarter with 9% year-over-year growth, a trend that has continued from previous quarters. Sales jumped double-digits in developing markets thanks to a rising middle class in Asia and Latin America. Within the segment, Skin & Personal Care outperformed hair care products.

That growth in developing markets is echoed in 2018 economic forecasts. Goldman Sachs forecasts solid 5.6% growth this year in emerging markets versus growth of just 2.3% in developed markets. India is expected to jump ahead with 8% GDP growth, followed by 6.5% in China, both well above growth of just 2.5% in the United States and 2.2% in the EU.

Nu Skin Enterprises (NYSE: NUS) is benefiting from two key trends: its strong presence in Asia where it books 79% of its revenue and leading brand awareness with millennials. The company has increased its dividend every year since 2001, now paying a 2% yield, and maintains a share repurchase program that returns excess cash to shareholders.

The company is expected to report $1.19 per share for the fourth quarter, a 50% increase compared to the same quarter last year, when it releases earnings mid-February. Expectations for $3.23 in 2017 earnings will bring the shares to 22.4 times earnings, about 12% below the industry average according to Morningstar data.

Avon Products (NYSE: AVP) has struggled since the financial crisis but now trades at a price that has attracted activist interest and may be ready to turn itself around. Barington Capital forced out the CEO late last year, and ownership by several private investor funds will pressure the company for a new direction.

Shares trade for a price-to-sales of just 0.2 times revenue versus an industry average of 2.8 times. The company has $664 million in balance sheet cash and a brand that still produces $5.7 billion in annual sales.

Healthcare also did relatively well, growing sales by 4% from the same quarter last year. Organic sales were up mid-single digits in both developed and developing markets with all the gain from volume. Within the segment, personal health care outperformed, with a sales increase in the high-single digits versus the same quarter last year, while oral care booked slightly slower growth.

While institutional healthcare services like hospitals and insurance providers have struggled against changes to the Affordable Care Act, over-the-counter health products continue to benefit from aging demographics and strong demand from millennials.

USANA Health Sciences (NYSE: USNA) is also benefitting from strong growth in Asia, with 71% of sales from the region, including 51% in China. The company’s health and wellness products are sold through an independent network, which keeps operating expenses low. Revenue has grown at an 11% annualized pace over the last decade and the company carries no balance sheet debt.

The Grooming division was by far the biggest laggard, with sales falling 3% from last year, followed by the Baby, Feminine and Family Care division, which saw sales fall 1% on a year-over-year basis. Both these divisions were flat or down in developed and developing markets on weak pricing and volume.

Risks To Consider: Pricing had a negative impact on P&G’s sales for the first time in 28 straight quarters, which means price competition is heating up and could weigh on the consumer staples sector. 

Action To Take: Position in smaller companies with strong brands in the Beauty and Health Care segments of consumer staples on continued growth within the sector, especially those with exposure to developing markets.

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