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Procter & Gamble: U.S. Key To Organic Growth

 December 11, 2012 09:45 AM

(By Mani) Post a largely uneventful analyst day, shares of Procter & Gamble Co. (NYSE: PG) remain stuck in a relatively tight trading range, with few discrete catalysts in sight.

Most agree the company dragged its feet in adapting to changing behavior in developed markets consumption over the last several years, with organic growth trailing peers for most of the last half decade the result.

Still, the tools necessary for the company to recover and re-accelerate organic growth are in place and the company now must execute on its ambitious cost savings plan and the promise of a significantly enhanced discontinuous innovation pipeline relative to the last several years.

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"In our opinion, and as we've discussed at length in the past, fixing the US remains the most critical aspect of the PG turnaround," Deutsche Bank analyst Bill Schmitz said in a client note.

After several quarters of negative growth, the US turned positive last quarter, a welcome sign, but investors likely need to see consistent sequential progress to get excited about this business that represents about 60 percent of the total company EBIT.

"Without the US growing low to mid single digits, it is prohibitively difficult for P&G to grow above its multinational peers, many of whom have much larger developing markets exposure," Schmitz noted.

Moreover, US price gaps remain stubbornly wide in top P&G categories and average since 2009 had barely moved from 32 percent to 31 percent.

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While the gap has notably closed in hair care categories, fabric softener, dog food, antacid, facial tissue, dish detergent, liquid body wash and diapers, there are many categories where price gaps have widened according to the scanner data, including paper towels, laundry detergent, disposable razors, mouthwash and home air fresheners.

Under this scenario, if growth surprises to the upside, utilization will improve and fixed overhead will be better leveraged, driving margin and EPS upside. Conversely, if growth remains tepid, company will have much more flexibility to weather the storm in a weak environment that would favor resilient consumer staples names like P&G.

"Outside of the US, the emerging markets per capita consumption expansion story remains compelling," the analyst said.

P&G has slowly been shifting its center of gravity away from slower-growing developed markets towards faster growing emerging markets in Asia, Central Europe, Africa and Latin America.

However, developing markets exposure still lags many peers, and P&G must commit to further moving its resources to take advantage of this opportunity.

In the meantime, the company is doing the right things by narrowing its focus and selected price gaps, with further operational improvement contingent on continued adept execution of productivity measures and innovation efforts.

"With valuation still compelling relative to group and company adequately resourced after this year's profit holiday to accelerate organic growth off a low base, we maintain our Buy rating and $75 price target," Schmitz added.

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