Shares of Procter & Gamble (PG) have appreciated by 27.9% since they reached the 52-week low of $59.07 in June 2012. At $76.56, the stock is trading near the 52-week high at $76.69 just achieved recently and offers a solid 3.0% dividend yield. Is a buy rating still warranted given the strong price uptrend? In this article, I will elaborate on the stock valuation analysis which may assist you in formulating an appropriate investment decision.
Sell-side analysts on average predict PG's revenue, EBITDA, and EPS to grow at CAGRs of 4.2%, 4.3%, and 3.2%, respectively, over the current and next calendar years (see comparable chart below). Those consensus growth estimates generally underperform the averages of 4.1%, 6.3%, and 10.5%, respectively, for a group consisting of PG's primary peers in the household product sector. Similarly, PG's EBITDA margin is forecasted to remain flat over the same horizon, compared to an average expansion of 1.0% for the comparable companies. On the profit side, PG has demonstrated a strong performance as all of the company's margin metrics are above the par. However, PG's capital return measures including ROE and ROIC are notably below the peer averages. The company carries a relatively lower level of debt as reflected by its below-average debt to capitalization ratio. In terms of liquidity, PG's free cash flow margin is markedly above the group average. Both the firm's current and quick ratios are below the par, reflecting a mediocre balance sheet performance.
To summarize the financial comparisons, PG's relatively weaker growth potential and capital return performance would likely be the primary drag on the stock valuation. However, given the company's significant operation scale and global presence as well as its above-average performance in profitability and cash flow generation, I believe the stock's fair value should trade fairly in line with the peer-average level. The current stock valuations at 11.8x forward EBITDA, 18.1x forward EPS, and 2.1x PEG are quite comparable to the peer-average trading multiples at 11.3x, 18.3x, and 2.1x, respectively, suggesting PG remains fairly priced despite the recent price appreciation (see chart above).
From a historical valuation perspective, PG's trailing EV/EBITDA multiple of 12.1x is now trading at 10.8% premium over its 5-year historical average at 10.9x (see chart below). The comparison suggests a reasonable valuation level based on the facts that:
1) PG's ROE has improved significantly over the past 5 years, and the company's other capital return measures including ROA and ROIC have also slightly increased (see chart below);
2) The firm was also able to sustain a steady performance for its various profitability and free cash flow margins (see chart below);
3) PG was able to slightly reduce the leverage and considerably improve the interest coverage ratio (see chart below); and
4) The market's consensus estimates predict PG's EBITDA to experience a more stabilized growth trajectory which is higher than its 5-year historical average (see chart below).
Alternatively, PG's forward P/E multiple of 18.1x is trading at 26.5% premium over the same trading multiple of the S&P 500 Index, which stands at 14.3x now (see chart below). Again, the fair value conclusion is reaffirmed provided that 1) the trading multiple premium averaged approximately 24.0% in the past 12 months; 2) PG's long-term earnings growth rate is estimated to be 8.5%, which is above the average estimate of 8.2% for the S&P 500 companies; 3) PG's geographically diversified revenue stream helps mitigating some of the earnings volatility; and 4) the stock offers a 3.0% dividend yield, which is notably above the market average yield.
I also performed a margin of safety analysis from a dividend standpoint. PG has a track record of raising dividend. Since 2009, the company has raised the dividend per share 3 times by 10.0%, 9.5%, and 7.0%, consecutively. Given PG's robust free cash flow generation, I believe the company has an ample capacity to sustain the current pace of the dividend growth. In addition, under the current low-interest market environment, a further upside for PG's 3.0% dividend yield would appear to be weighed by strong investor demand for high-yield assets. As such, assuming a target dividend range from 3.0% and 3.5% (PG has an 3-year historical average yield at 3.2%), and supposing that the annualized dividend per share would be raised by the same rate at just 5.0% over the current and next years from the present level at $2.25 to $2.48 in April 2014 payment period, this conservative scenario would suggest a 1-year stock value range from $70.86 to $82.67, or a favorable price return from -4.4% to 11.0% after considering the 3.0% dividend income.
"PG delivered a much better than anticipated FQ2, with EPS and organic sales growth surpassing our estimates by $0.10 and 1%, respectively. While PG's organic sales growth trails peers (KMB, Unilever, and Beiersdorf have reported better CQ4 revenue growth), we are encouraged by the sequential improvement, which should continue…We rate Procter Overweight. In our view, PG has gained more conviction on ongoing cost savings, as evidenced by its recent revelation about a $10 billion cost saving opportunity, which should drive much needed operating margin expansion for the first time in years. We think the stock's valuation relative to peers should move up as the company's efforts to contain costs and gain share start bearing fruit."
Bottom line, despite the recent positive development, my valuation analysis concludes that PG is trading within its fair value range. However, given the solid downside protection by the expected dividend growth and the sustainable dividend yield, there remains a modest margin of safety for the investment and thus a long rating is still warranted. To limit the risk, I would recommend selling out-of-money put options to either collect upfront premium or take a potential opportunity to acquire the shares at a lower price level.
All charts are created by the author and all financial data in the article and the charts is sourced from Capital IQ unless otherwise specified.