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Strong Dollar Weighs on P&G, But Wide Moat Intact

We’re lowering our fair value estimate for Procter & Gamble due to the negative impact of currencies, but the firm’s underlying business is gaining traction and shares look modestly undervalued.

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While  Procter & Gamble’s (PG) headline second-quarter results were bleak (with sales down 4% and earnings before tax off 8%), we haven’t swayed from our view that the firm’s underlying business is gaining traction. As such, P&G’s wide moat, which stems from its expansive scale and brand power, is firmly in place. However, in light of the negative impact foreign currency is having on current-year results, we’re taking our fair value estimate down to $90 per share, from $94. We now expect sales to slip 3.7% this year (which compares with 1.7% growth previously), and operating margins to approximate 19.4% (versus 20.1% previously). The profit impact is more pronounced, as the firm isn't manufacturing in the locations it is selling, a challenge that is unlikely to abate, but is not indicative of the firm’s fundamentals. Shares are off around 3%, and at a slightly larger discount, we’d contend that the stock would be an attractive investment in a sector where discounts are few and far between.

Excluding foreign currency rates and one-time charges (including a $0.26 per share impairment related to its battery business), sales ticked up 2%, driven by higher prices and favorable product and geographic mix, and operating margins contracted 60 basis points to 20.2%. We still believe efforts to bring new products to market that prove valuable to consumers are paying off. In fact,  Kimberly-Clark (KMB) recently noted that it suffered share losses at the hand of P&G in both U.S. diapers and adult incontinence. This commentary runs in line with P&G’s disclosure at its investor conference in November 2014 that Pampers (P&G’s largest brand, with $10 billion in annual sales) had overtaken Huggies and now controls around 38% share of the U.S. diaper market, about 300 basis points above the level held by Kimberly.

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Erin Lash does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.