Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheets of Procter & Gamble PG and Unilever UL, in order to get some clues as to how well these companies are doing.
I will go through the balance sheets of these two companies, reviewing the most important items, and seeing if there are any major differences between the two, making one a better investment than the other. Information that I used on P&G can be found here, and information on Unilever can be found at this link. Note that this article is not a comprehensive review as to whether either of these two stocks should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
As most everyone knows, Procter & Gamble is the 900-pound gorilla of the consumer products industry, with a market capitalization of approximately $207B. They manufacture and sell products that are used in beauty, grooming, healthcare, fabric care, and baby care. Some of their more notable brands include Gillette, Tide, Gain, and Vicks. In fact, they have about two dozen brands that are each bringing in $1B or more in revenue every year. Their products are sold in 180 countries, while they have on-the-ground operations in 75 countries. Over the last twelve months, P&G got 42% of its $83.3B in revenues from emerging markets in Asia, Africa, Latin America, and Central and Eastern Europe, leaving room for growth in this area.
Unilever is also a beast in the consumer products industry. They offer many of the same types of products as P&G, such as Dove soaps and Surf laundry detergent, but they also produce and sell food items, like Hellmann's mayonnaise, ice cream, Lipton teas, and Slim Fast products. They have a market capitalization of approximately $112B. In 2012, they recorded 51.3 billion euros ($68.8 billion U.S.) in sales, with 55% of it coming from the emerging markets. Since Unilever is headquartered in Europe, most of their earnings and other items are reported in euros.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
Procter & Gamble is one such company. As of Dec. 31, 2012, P&G had $6.6B in cash. While $6.6B is not a lot of money for a company with an approximate market capitalization of $207B, you should keep in mind that this company bought back over $6.2B in stock over its trailing twelve-month period and paid out about the same amount in dividends, which are well-supported by its free cash flows of $10.7B over the same time period.
Unilever had 2.5 billion euros ($3.35 billion U.S.) in cash as of the end of 2012. For a company with a $112B market cap, that doesn't seem like a lot of money, but it did pay out 2.7 billion euros ($3.62 billion U.S.) in dividends, which are well-supported by free cash flows of 4.7 billion euros ($6.30 billion U.S.) over the same time period.
The table below illustrates this information pretty clearly. From looking at this table, it looks like Procter & Gamble repurchased shares at a favorable price, relative to where it is trading now. If this remains the case, then it will be a positive for shareholders, as they now have a greater stake in the equity of the company, which is now worth more. P&G also saves money on dividends that it would otherwise have to pay out on those repurchased shares. So, hopefully, that translates into more dividends for current shareholders. I couldn't find where Unilever had repurchased shares over the last twelve months.
Dividend Payouts (TTM)
Average Buyback Share Price
2.5B EUR ($3.35B)
2.7B EUR ($3.62B)
Table 1: Cash Positions and What PG and UL Do With Their Cash
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
Procter & Gamble had a total of $7.18B in net receivables on its balance sheet, which represents 8.6% of its trailing twelve-month sales of $83.3B. Unilever had 4.4 billion euros ($5.90 billion U.S.) in net receivables, amounting to about 8.6% of its 2012 sales of 51.3 billion euros ($68.8 billion U.S.).
I don't see anything at all to worry about in this department for either company.
With manufacturing companies like the ones we're reviewing today, I like to keep an eye on inventory levels. I usually like to see inventory levels stable or slightly rising from one year to the next. If I see inventory levels rising, then I want to see revenues rising as well, to indicate higher demand for the company's products. I don't like to see rapidly fluctuating inventory levels that are indicative of boom and bust cycles. In some instances, if inventory ramps up without increases in volumes or revenues, then it may indicate that some of the company's products are going obsolete. We don't need to worry about that here, though, as I don't believe that soap and toilet paper are going to be obsolete any time soon!
Fortunately, that is not a problem with P&G or Unilever. Procter & Gamble has approximately $7.2B in inventory as of the end of calendar 2012, slightly down from the $7.4B it had one year prior. Unilever had 4.4 billion euros ($5.90 billion U.S.) in inventory, versus 4.6 billion euros ($6.17 billion U.S.) a year ago. These levels are slightly down, but not enough to concern me.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of their operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of Procter & Gamble is 0.98, while Unilever sports a current ratio of 0.77. P&G seems to be okay in this regard, while the current ratio of Unilever is less than ideal. However, I wouldn't worry too much about Unilever in this regard, because what are the odds that the entire operations of Unilever come to a grinding halt? It is something to consider, nonetheless, but I would be a lot more concerned if I was dealing with a smaller and younger company with operations that are concentrated in just one or two places, as opposed to all over the world, like these two companies.
With companies that have significant amounts of inventory, I like to consider another ratio that is known as the quick ratio. While inventory is generally regarded as a current asset that can be converted into cash within a year, what if it can't be converted for some reason or another? The quick ratio takes this uncertainty into account. When calculating the quick ratio, just subtract the inventory from the current assets, and then divide the rest by the current liabilities. Ideally, you like to see this ratio at 1.0 or above. However, for P&G, this ratio comes out to 0.70, while it is 0.49 for Unilever. This is less than desirable for both companies, but as with the case of the current ratio, I don't expect any major disruptions in the operations of either of these two companies, since they have operations all over the world.
Property, Plant, and Equipment
Manufacturing, like any other industry, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant, and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.
However, another way of looking at it is that large amounts of money invested in this area may present a large barrier to entry for competitors. Right now, Procter & Gamble has $21.2B in property, plant, and equipment on its balance sheet, while Unilever has 9.4 billion euros ($12.61 billion U.S.) on its balance sheet in this area.
With both of these companies, the biggest intangible asset is goodwill. Goodwill is simply the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case by case basis, as good companies are rarely purchased at or below book value. Procter & Gamble has $55.7B of goodwill on its balance sheet, which is steady versus a year ago, while Unilever is carrying about 14.7 billion euros ($19.7 billion U.S.) in goodwill. Both of these companies also have intangible assets like trademarks, patents, and the like. These other intangible assets total $32.1B for P&G, and 7.1 billion euros ($9.52 billion U.S.) for Unilever. These assets are important as trademarks, patents, and brand strength can present another barrier to entry against would-be competitors.
Due to the problems with goodwill that I just spoke about, you generally don't like to see intangibles account for more than 20% of total assets. However, they account for 63% of P&G's assets and 47% of Unilever's assets. However, you must also consider that much of these assets are good, in that trademarks, brand strength, and patents aren't going away like lost goodwill from a bad acquisition. So, I wouldn't be too worried about this.
Total Intangible Assets
Intangible Percentage Of Total Assets
21.8B EUR ($29.2B)
Table 2: Percentage of Total Assets That Are Intangible
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For P&G, the return on assets would be $11.8B in core earnings, divided by $140B in total assets. This gives a return on assets for the trailing twelve months of about 8.43%, which isn't bad, considering that a huge asset base of $140B serves as another good barrier to entry. For Unilever, the return on assets is 5.0 billion euros ($6.71 billion U.S.) in core earnings, divided by 46.2 billion euros ($62.0 billion U.S.) in total assets, producing a return on assets of 10.8%, a little bit better than P&G. Overall, both companies are doing fine here.
Return On Assets
Table 3: Great Returns On Assets From Both Companies
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
P&G carries $9.8B in short-term debt, while Unilever carries 2.7 billion euros ($3.62 billion U.S.). Given the creditworthiness of Procter & Gamble, and the interest rates being as low as they are, I expect P&G to refinance a significant portion of this debt. As a result, I am not too worried about P&G for the time being, but eventually, the money has to be paid back. So, the situation with the short-term debt and Procter & Gamble is less than optimal.
Long-term debt is debt that is due more than a year from now. However, an excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, Procter & Gamble carries $23.6B of long-term debt, while Unilever carries 7.57 billion euros ($10.2 billion U.S.) of long-term debt.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of each company's core earnings over the last 3 years. The average earnings of P&G over this period is $11.5B. The 3-year average for Unilever is 4.56 billion euros ($6.12 billion U.S.). When you divide the long-term debt by the average earnings of each company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For P&G, here is how it looks: $23.6B / $11.5B = 2.05 years
For Unilever, it looks like this: $10.2B / $6.12B = 1.66 years
This is fantastic for both companies, while I give the slight edge to Unilever here. As long as these two companies can continue to generate these kind of earnings, they should be able to manage their long-term debts without any major problems.
In the equity portion of the balance sheet, you will find the treasury stock. This figure represents the shares that the company in question has repurchased over the years, but has yet to cancel, giving the company the opportunity to re-issue them later on if the need arises. Even though treasury stock appears as a negative on the balance sheet, you generally want to see a lot of treasury stock, as strong, fundamentally-sound companies will often use their huge cash flows to buy back their stock. For this reason, I will usually exclude treasury stock from my calculations of return on equity and the debt-to-equity ratio in the case of historically-strong companies, as the negative effect of the treasury stock on the equity will make the company in question appear to be mediocre, or even severely distressed, when doing the debt-to-equity calculation, when in reality, it might be a very strong company.
Procter & Gamble has a very impressive treasury stock figure of $71.7B. Unilever, on the other hand, doesn't have any significant treasury stock that can be found on their balance sheet.
The debt-to-equity ratio is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how Procter & Gamble and Unilever stack up here.
Debt To Equity Ratio = Total Liabilities / Shareholder Equity
For P&G, it looks like this: $72.6B / $67.3B = 1.08
And for Unilever: 30.5B EUR($40.9 billion U.S.) / 15.2B EUR($20.4 billion U.S.)= 2.01
A variation of this ratio that I like to use takes into account the presence of treasury stock on the balance sheets of very strong companies (like P&G). When there is over $71B of treasury stock on the balance sheet, the regular debt-to-equity ratio makes it look like Procter & Gamble is a severely distressed company, when we all know that it's not. Here, I add the treasury stock back in to the equity, as treasury stock can be re-issued at a later date if the need arises (although you hope that never happens). I call this ratio the adjusted debt-to-equity ratio. It's calculated like this.
Adjusted Debt To Equity Ratio = Total Liabilities / (Shareholder Equity + Treasury Stock)
For P&G, it looks like this: $72.6B / $139B = 0.52
For Unilever, this value is the same as the regular ratio due to there being no significant treasury stock on the balance sheet.
For the sake of comparison, I also calculated these ratios as of the end of calendar 2011. P&G had a debt-to-equity ratio of 1.07, while Unilever carried a ratio of 2.19. So, the debt-to-equity ratio for Procter & Gamble has been steady, while there has been small improvement in Unilever.
Overall, I give Procter & Gamble the edge in this department. The table below illustrates what I just discussed here.
2012 Debt/Equity Ratio
2011 Debt/Equity Ratio
Table 4: Debt To Equity Ratios Of Procter & Gamble And Unilever
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula. Note that this is the adjusted form, which negates the negative impact of treasury stock on the equity.
Return On Equity = Net Income / (Shareholder Equity + Treasury Stock)
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. Once again, this is why I strip the negative effect of treasury stock from my calculations.
So, the return on equity for P&G is as follows:
$11.8B / $139B = 8.49%
For Unilever, it comes out as: 5.0B EUR($6.71 billion U.S.) / 15.2B EUR($20.4 billion U.S.) = 32.9%.
If you do the calculation like most and count the treasury stock as a negative to equity, then Procter & Gamble would have an even higher return on equity of 17.5%.
I think that both of these returns on equity are decent, while that of Unilever is clearly better. However, I believe that the exceptionally high figure posted by Unilever has a lot to do with its relatively small equity position that comes partly from its debt. Hopefully, as the debt-to-equity ratio improves, we'll see the return on equity return to more reasonable levels.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Procter & Gamble has $79B of retained earnings on its most recent balance sheet, while I cannot find this figure on any of Unilever's balance sheets, since they don't do a good breakdown of the shareholder equity. I couldn't even find it on their SEC filings. Going back to the end of 2009, P&G had retained earnings of $70.7B.
As far as who is better in this regard, it is inconclusive, as we don't have this information available on Unilever. However, we can see that P&G has increased its retained earnings at a cumulative rate of nearly 12% over the last three years.
After reviewing the balance sheets of both Procter & Gamble and Unilever, we see that both of these companies have several things in common. Some of these include small cash positions relative to their market capitalizations, generous dividend payouts, strong earnings and cash flows, as well as decent returns on assets and equity.
However, I just cannot put Unilever over P&G with that debt-to-equity ratio being as high as it is. It's nice to see that this ratio is coming down some for Unilever, but we will need to see continued improvement in this area. Procter & Gamble's larger asset base also provides a bigger barrier to entry against would-be competitors. Unilever, whose assets total less than half of P&G's, doesn't have this kind of protection. It should also be said that P&G has almost $72B in treasury stock that it can re-issue at any time if they need to. Unilever does not have this at their disposal.
With all of that said, I believe that Procter & Gamble has the better balance sheet. However, if Unilever can improve on its debt-to-equity ratio, the comparison might be a lot closer.
With that said, while I think that P&G has a pretty good balance sheet, the stock may have gotten a bit ahead of itself at $75. I still own it, but I would wait for either a pullback or a dividend increase to buy more.
Thanks for reading and I look forward to your comments!
Disclosure: I am long PG.