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Will the Old Spice Lawsuit Hurt P&G’s Margin in Fiscal 3Q16?

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Fiscal 2Q16 revenue and EPS highlights

In fiscal 2Q16, Procter & Gamble (PG), or P&G, came in ahead of Wall Street analysts’ estimates on earnings for the third straight quarter, while it missed sales estimates for the fifth consecutive time. Core adjusted EPS (earnings per share) rose 9% to $1.04 while revenue fell 8.5% to $16.9 billion in fiscal 2Q16. Reported revenue was negatively impacted by foreign exchange (8% impact) and by Venezuelan deconsolidation and minor brand divestitures (3% impact).

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Fiscal 2Q16 margin update

P&G reported its gross margin increased 170 basis points to ~50% in fiscal 2Q16 compared to its gross margin in fiscal 2Q15. On a currency-neutral basis, gross margin increased 290 basis points, driven by 170 basis points of productivity cost savings, 100 basis points from lower commodity costs, and 130 basis points from pricing benefits.

The company’s operating margin for fiscal 2Q16 also rose to 22.8% compared to 19.4% in fiscal 2Q15. The increase was due to productivity savings.

Cash flow productivity

Despite a weaker top line, P&G continues to focus on value creation and cash. P&G is one of the strongest cash generators among its peers and mega-cap companies like Unilever (UL), Colgate-Palmolive (CL), and Kimberly-Clark (KMB). P&G generated $3.8 billion in adjusted free cash flow with 117% adjusted free cash flow productivity, despite the investments made in supply chain transformational moves.

Negative publicity could impact margin growth

With continued strong operating margin expansion, the company expects to deliver core operating income growth in the mid- to high-single digits. However, with the lawsuit filed against P&G’s Old Spice, margins could contract in the coming quarter as revenue would be affected. In India, P&G de-prioritized unprofitable lines of business, which has negatively impacted short-term growth but will improve local profit margin significantly. This will help to strengthen operations and margins.

In the next part of this series, we’ll discuss how the Old Spice lawsuit has affected P&G’s valuation multiple. We’ll also look at the company’s initiatives for future growth.

PG forms 1.1% of the PowerShares S&P 500 Low Volatility Portfolio (SPLV).[1. Updated on March 28, 2016]

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