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P&G Stays Neutral; Margins Weak

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On Dec 12, we maintained a Neutral recommendation on The Procter & Gamble Company (PG - Free Report) , despite decent first-quarter fiscal 2014 results. Though the company is showing top-line traction, we would like to see significant margin improvement before being more positive on the stock.

Why the Neutral Recommendation?

Despite significant currency headwinds, P&G reported decent fiscal first-quarter 2014 results meeting the Zacks Consensus Estimate for earnings and beating the same for sales. Excluding currency headwinds, earnings increased 8% in the quarter as a strong top line, cost savings and lower taxes made up for the sluggish margins in the quarter. Organically, revenues were up 4% due to strong volume growth on the back of robust innovation efforts and higher marketing investments.

However, margins were weaker, for the second quarter in a row, due to currency headwinds, unfavorable geographic/product mix, and higher commodity and manufacturing startup costs. Second-quarter 2014 margins will also be pressured by similar currency headwinds, higher promotional spend and other cost headwinds. Though weaker in the first half, profits are expected to increase in the second half driven by accelerated productivity gains and cost savings, and moderating currency headwinds.

P&G undoubtedly commands solid long-term fundamentals with strong brand recognition, diversified portfolio, rapid growth in developing nations, impressive product development capabilities and marketing prowess. The company’s improving market share trends, disciplined geographic/product expansion and accelerated cost savings bode well for further growth.

However, though some signs of modest economic recovery and improving consumer confidence can be seen in the U.S., there is still great uncertainty. The U.S. consumers are burdened with higher gasoline prices, payroll tax increases and delayed tax refund checks. These external forces might restrict consumers’ discretionary spending in addition to slow job growth, high interest rates and tightened credit availability.

P&G is also facing business disruption and substantial price reductions in Venezuela following the publication of new price control regulations in the country. Moreover, volatile market dynamics in countries like Argentina (import restrictions and price controls), Egypt, Syria and South Korea have added to the woes. Foreign exchange is also a major headwind with around 60% of the company’s business generated outside North America. Foreign exchange hurt the company’s revenue growth by 2% in fiscal 2013 and is expected to hurt top line by another 2% in fiscal 2014. All these issues prevent us from being too optimistic about the stock.

Other Stocks to Consider

P&G carries a Zacks Rank #3 (Hold). Other better-ranked food companies are Pinnacle Foods Inc. (PF - Free Report) Green Mountain Coffee Roasters, Inc and Omega Protein Corporation . While Omega Protein sports a Zacks Rank #1 (Strong Buy), Pinnacle Foods and Green Mountain carry a Zacks Rank #2 (Buy).

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