Inflation Turns Procter & Gamble’s Reported Growth Into A Downturn

P&G’s Wednesday (January 19) quarterly earnings report started out with high promise: 6% sales growth and 13% EPS growth year-over-year ($1.66 vs. $1.47).

Then came the facts that chipped away at those growth rates significantly. In the end, even the paltry 1% EPS growth rate dropped – to a negative (2.7)%.

Here are the five steps that take the results from great to okay to negative (all the data is in two tables at the end of the article).

Note: The reported October-December quarter is the 4th 2021 calendar quarter, but the 2nd 2022 P&G fiscal calendar. For clarity I will refer to the calendar quarters.

First – Previous year (4th quarter 2020) had two EPS numbers

The earnings report also says that “Core” EPS grew, but only by 1%, not 13%. Why? The previous year had a large expense from P&G buying back its own bonds at a price higher than when they were issued. GAAP (Generally accepted accounting principles) says include the expense, producing the $1.47 amount. P&G’s non-GAAP adjustments logically remove such non-operational expenses, thereby producing a better number for comparison: $1.64. Hence, the year-over-year growth to the 4th quarter 2021 EPS of $1.66 drops from 13% to 1%.

Second – Only half of sales growth is due to consumer behavior

P&G reports that one-half of the 6% sales growth is due to price increases. Thus, the non-price product sales growth was 3%.

Third – Profitability numbers shrank significantly

Those two growth rates indicate the problem: Sales up 6% and EPS up 1%. Typically, when sales grow, earnings rise at a higher rate. P&G’s mismatch shows something went wrong between gross and net. Here are the results:

• Cost of products sold (normally around 50% of revenues) rose much higher: Up 15%. That caused a decline in gross profit: Down (2)%.
• Selling, general and administrative (SG&A) expenses stayed steady – 0%. Because they are about one-half of gross profits, the decline in gross profits fell entirely onto net profits: Down (4)%.
• All other expenses (e.g., net interest and income taxes) declined (14)%, thereby offsetting much of the net profits decline. Net income: Down (1)%.

Fourth – Share buybacks reduced the per share divisor

P&G’s buybacks reduced the “diluted weighted average common shares outstanding”: Down (3)%. Dividing by a smaller number changed that total net income decline of (1)% to an earnings per share increase of 1%.

Thus, Procter & Gamble eked out EPS growth. However, the more important information from above is:

• P&G doubled revenue growth by raising prices
• The increase in cost of goods more than offset sales growth
• P&G was able to hold SG&A expenses flat in an inflationary period
• Share buybacks converted a net income decline into an EPS rise

Fifth – An important adjustment not in the P&G report

All those P&G results are in dollars. However, with inflation, the value of those dollars declines over time. Therefore, those dollars need to be adjusted for inflation’s erosion to calculate “real” growth. (This is the same process economists use for GDP and many other dollar-based measures.)

So, what inflation rate should be used for the fourth quarter 2021 and 2020 comparisons? Looking through the latest BLM report for the CPI helps. While there are some high price jumps that pushed the CPI up 7%, most industry price rises centered around 4%. So, that’s what we’ll use.

Here’s how the price pattern has evolved for CPI, Personal Consumption Expenditures (PCE), GDP and CPI excluding food and energy (4th quarter GDP and December PCE have not yet been reported)…

Doing a backwards adjustment (i.e., putting all numbers in fourth quarter 2021 dollars) produces these changes: (Second table below shows the data)

• Sales: Reported growth rate of 6.1% becomes “real” inflation-adjusted rate of 2.0%
• Net income: Reported (1.4)% drop becomes (5.1) decline%
• EPS: Reported 1.2% growth becomes (2.7)% decline

These results show why P&G management announced price increases last July and have just reiterated the need to continue doing so.

Table 1 – The reported data

Table 2 – The inflation-adjusted data

The bottom line: Businesses now have a major challenge to produce “real” growth

Inflation doesn’t naturally fall into business leaders’ laps. Raising prices without harming demand is tricky. Then there is the need to keep a lid on rising costs (and that includes employee pay).

As consumers begin to combat inflationary price rises, investors need to ensure their companies’ fundamental growth is real.