Seeking Alpha
Long/short equity, research analyst, tech, alternative energy
Profile| Send Message| ()  

Introduction

Procter & Gamble (PG) is one of the biggest consumer goods companies in the world, with annual sales of $84 billion. The company has 25 brands such as, Pantene, Braun, Gillette, Oral-B, Vicks, Crest, Dawn, Duracell, Tide, Bounty, Olay and Pampers, that generate over $1 billion in sales. The company sells a wide range of products under different brand names in over 180 countries. The company has the reputation of being a safe, recession proof, high dividend yielding stock. However, in recent times, the company has underperformed its transnational global consumer goods peers, such as Kimberly-Clark (KMB), Colgate-Palmolive (CL) and Johnson & Johnson (JNJ). P&G announced a major restructuring plan, to save $10 billion in costs and plans to fire 10% of its non-manufacturing workforce of 57,000.The stock took a hit in June 2012, after the company cut its revenue guidance.

P&G Strengths

  1. Dividends - There are very few large cap companies that have the dividend yielding record like P&G. The company has increased its dividends for the last 56 years, with a dividend growth rate of ~11% in the last decade itself.

  2. Emerging Market Exposure - P&G has one of the best emerging market exposures amongst its competitors, with almost 40% of its revenues coming from these fast growing markets. It has consistently clocked a greater than 20% y/y, revenue growth in the BRICs markets. The company has reoriented its strategy to focus more on 10 key emerging markets.

  3. Brand Power - PG has a portfolio of some of the best consumer goods brands in the world, which stand for trust and quality. This allows P&G to garner a big price premium for its products in most countries. In countries like India and China, P&G has managed to outshine local competitors, as its brands stand for quality. Regulation is weak in these countries and so fear of adulteration and bad quality is quite high. This means that global companies like Unilever (UL), Pepsi (PEP) can afford to price the same quality of goods at much higher prices.

  4. Restructuring and Cost Cutting - P&G has realized that it needs to clean up its act, as margins have taken a hit in the recent past. The company announced additional cost cuts in November 2012, on top of the 10% non-manufacturing workforce cuts in June. The company plans to reduce 2-4% of its non-manufacturing jobs each year, in the next three years.

  5. Increasing Share Buybacks - P&G is becoming more shareholder friendly, as it has increased its share buyback plan by 50%, from $4 billion to $6 billion. The company already gives a 3% plus dividend yield.

P&G Risks

  1. Falling Sales - P&G overall revenues slowed down last year, due to a mix of slower growth and foreign exchange losses. The company expects only a 2-4% organic topline growth in FY13, with core earnings expected to grow by 1%. The company is expecting sales of ~$84 billion with EPS of $3.8-4.0, which is roughly flat with FY12.

  2. Developed Markets Slowdown - U.S. and Europe are experiencing a sharp economic growth slowdown, which is badly affecting P&G. These regions still account for a majority of P&G revenues, which means that P&G faces strong headwinds. Emerging markets may also start to feel the effects of slowing exports, which would further exacerbate the sales decline for P&G.

  3. Competition has performed better much better - P&G has performed poorly compared to its main competitors like CL and JNJ. Not only have earnings been more volatile, but the overall growth rate has also declined. This has led to a poor stock performance compared to the other stocks. While the dividends have not been cut, the payout ratio has increased quite considerably, as more and more of earnings are diverted to shareholders.

  4. Margins have stagnated while ROE has almost halved - The company's margins have stagnated in the last decade, with GM stuck in the 50-52% range and Operating Margin in the 18-20% range. The ROE in recent years has gone down quite substantially from the 40% range in the beginning of the decade. The ROIC has also shown a similar decline, falling to 11% in the last 12 months.

Valuation is not Cheap

P&G is trading at higher than industry P/E and P/S multiples, at 22.5x and 2.5x, respectively. The revenue and EPS growth in the last 3 years, are below the industry average. The ROE at 16.8% is also lower than the industry average at 22.4%. The company has generated ~$9.5 billion in FCF in the last couple of years with the P/C at ~15x.

Poor Stock Performance

P&G has performed quite poorly compared to the broader stock market and other consumer goods companies like Johnson & Johnson. The company has given a negative 4% return, compared to ~37% for CL and ~4% for the S&P 500. Even in the last one year, P&G has underperformed the S&P 500 by ~10%. The company's stock has also shown much higher volatility, compared to other consumer goods stocks. The stock dropped sharply in June 2012, to $59 after it cut its guidance.

Summary

We think that P&G is priced a bit too high, considering the falling sales growth and falling investment return ratios. The reason for the higher valuation of P&G, like other "safe", large cap, high dividend yielding stocks, is the low interest yield environment. With the global central banks artificially suppressing interest rates, investors have little option but to turn towards blue chip transnationals with a decent dividend yield. The risks in these companies are being ignored, leading to many such companies trading at their all time highs. P&G has not performed well in the last decade, with earnings being quite volatile. While P&G management may have initiated measures to stem the rot, sales growth has become flat. It is hard to imagine how the company will increase its dividend in the future without earnings growth. The payout ratio has increased to ~68% from the 40% range earlier. While the non-manufacturing job cuts may give the stock price a boost in the short term, it may not bode well for the company's sales growth in the future.

Source: Procter & Gamble - Restructuring Priced In, Time To Sell