procter and gamble (PG -0.69%) is a consumer staples giant with a global portfolio of industry-leading brands and a massive $360 billion market capitalization. The company has long relied on innovation to drive growth in its business and service areas, which helps it stay at the top of the industry.
And while P&G's second quarter of fiscal 2024 was also strong, there were two issues that investors need to understand.
P&G had a mostly strong quarter
P&G's sales for the second quarter of 2024 increased by 3% year-on-year. This may sound like a conservative number, and it is, but it's a good number for a consumer staples company. The normal pace is slow and steady. The big boost across the company's five major businesses was due to price increases, with sales increasing his 4 percentage points. The big negative factor in the quarter was the exchange rate impact, costing the company his 1 percentage point.
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Notably, sales volumes remained flat overall despite price increases. This is important because P&G, like other consumer staples companies, has been raising prices fairly rapidly over the past year or so to offset the impact of inflation on its business. In effect, they are passing on increased costs to consumers. There's nothing unusual about this tactic, but this time the price hikes were larger and more frequent. The normal reaction of consumers is to buy less when prices rise. So it was really good news that P&G was able to maintain volume across its portfolio while increasing prices (again).
There were some subtleties this quarter, with Chinese customers boycotting Japanese brands such as P&G SK-II cosmetics. The company expects this to be temporary. However, there were also non-cash claims, which required investigation.
What exactly did P&G earn?
On an adjusted basis, P&G's profits rose 16% year over year. However, based on Generally Accepted Accounting Principles (GAAP), the company's profit decreased by 12%. This is a big difference, and it's worth considering why the difference exists. Essentially, the company's adjusted numbers are a distillation of items that are considered one-time in nature. The largest loss in the quarter was a $1.3 billion pre-tax impairment of Gillette's book value. In its latest quarterly report, the company explains:
This impairment charge resulted from a decrease in the estimated fair value of Gillette's indefinite-lived intangible assets due to higher discount rates, the depreciation of several currencies relative to the U.S. dollar, and the impact of the non-core restructuring program described above. This impairment charge adjusted the carrying value of Gillette's indefinite-lived intangible assets to fair value.
The non-core restructuring program noted in the comments centers on P&G's transition from producing products within a particular market to importing products manufactured elsewhere into that market. What exactly does this mean?
First, when a company acquires another company, it typically pays a premium. To simplify things, that premium is lumped together as an intangible asset tied to something like a brand name. The $1.3 billion reduction in Gillette's value suggests that Gillette is not worth as much as the company once expected.
This is not surprising, given the changes that have taken place in the field of grooming, namely the growing popularity of growing a beard. Gillette also faces emerging brands offering lower-priced razors online, in stores and through subscriptions. In fact, the company wrote off the value of its business by $8 billion in 2019, so the latest impairment amount is relatively modest.
That being said, the current writedown suggests that the shaving market is still very competitive and Gillette doesn't have the dominance it once did. Gillette still generates a lot of cash flow for P&G, which is not good news.
It also involves a shift from production in one country to import into that country. This is a bit of a departure from previous approaches and highlights that operating in some markets, primarily smaller emerging economies, is more difficult than P&G expected. There are good reasons for this, including difficulties in procuring raw materials due to government-imposed financial constraints (in layman's terms, P&G is unable to obtain the US dollars needed to purchase goods domestically). However, it still means that the approach taken by management did not work as planned.
Overall still good
One-time items in P&G's fiscal second quarter should not deter investors from owning the stock. The company remains an industry giant with a strong business. But it's a reminder that even industry leaders aren't perfect.
Overall, investors should continue to expect headwinds for Gillette and keep an eye on emerging markets. These offer more growth opportunities, but as we've seen this quarter, this can come with higher risks. So, while you probably don't need to worry, you shouldn't ignore one-time items that are effectively hidden by adjusted earnings.
