Procter & Gamble's Hidden Source Of Value

| About: The Procter (PG)

This article is part of an ongoing series that highlights specific companies that are on sale. It helps me to document my thought processes when I add to my holdings or initiate new positions. Please provide your feedback in the comments section below.

Procter & Gamble (NYSE:PG) is currently offering investors an opportunity to buy portions of the company at $81/share. The stock has been steadily declining for the past two months since reaching it's 52 week high and may provide a good entry point. Right now, PG is about five percent off the 52 week high, hit a couple months ago at about $86 per ownership interest. This few brief pullback provides long-term investors with a good opportunity to initiate a position. Essentially, PG has earned two whole months' worth of profit and repurchased two entire months' worth of shares, yet the price is lower than it was before those two months.

Procter & Gamble has a business model that is simple and sustainable. It manufactures and sells consumer goods through five divisions: Global Beauty, Global Baby, Feminine, & Family Care, Global Fabric & Home Care, and Global Health & Grooming. Procter & Gamble has competitive advantages in the brands that they own; who hasn't heard of Duracell, Dawn, or Tide? Procter & Gamble is also able to increase its revenue at a rate that keeps up with inflation, passing along the devastating effects of inflation on to the consumer, not the owners. According to the 2013 Annual Report, sales growth was 3% year over year. Core EPS rose 5% year over year. Additionally, PG is investing for future growth.

Despite the growth, I believe that Procter & Gamble trades at a discount to it's true valuation. PG currently trades at about 20 times ttm earnings and 17 times projected next year earnings. EPS is expected to grow over 8% next year and average over 8% for the next five years. PG appears to be turning around now, and I am content to accumulate shares at this perceived discount.

Also, Procter & Gamble is a cannibal! PG has been buying back it's own stock at a pace that affects the bottom line. Just one quarter ago, three short months, there were over 2.74 billion shares outstanding of PG. Today, there are under 2.72 billion diluted shares. In a few short months, Procter & Gamble has retired over almost a percent of its outstanding share volume! In four years, the company has retired over 7% of it's outstanding shares. The company has indicated on many occasions that returning cash to shareholders via share buybacks is an important goal for management. They are using their free cash flow to buy out other shareholders, which further adds to the gains of the remaining shareholders.

With Procter & Gamble buying so much of their outstanding shares, let's look at how that will affect earnings. Analysts are expecting a consensus EPS of $1.20 for the next quarterly earnings release, with the lowest estimate coming in at $1.15. For reference, PG reported EPS of $1.22 for the same quarter last year. It doesn't appear that analysts are expecting much, if anything, from Proctor & Gamble. With PG's large share buyback activity, it wouldn't have to make more in total earnings to affect the bottom-line EPS. Even if profits stagnate, EPS will increase due to the share buyback. I believe that Procter & Gamble will have a positive surprise, and this is the catalyst that will cause PG to break out from it's recent downward trend and close substantially higher at the end of 2013.

Let's take a quick look at a few of PG's competitors, Colgate-Palmolive (NYSE:CL), Kimberly-Clark (NYSE:KMB), and Unilever (UL). PG is trading at the lowest P/B of the bunch, with a price-to-book ratio that is almost half of the next closest competitor. Procter & Gamble also has the lowest long-term debt-to-equity and total debt-to-equity ratios, by far. Procter & Gamble is the type of company that I want to own for the long haul, and this appears to be an opportune time to add to my position.

Procter & Gamble also has a solid yield for such a stable company. You literally get paid to wait. PG has a current yield of over almost 3%. During the financial crisis, Procter & Gamble did not cut it's dividend. In fact, it raised the dividend! Procter & Gamble is a Dividend Champion and has raised it's dividend every year for 57 years. It's dividend growth is at a much faster pace than inflation. That means that if you are relying upon dividend income to sustain you, you would not lose purchasing power over time. In fact, it would grow. PG is both a buyback king and a dividend king!

Combined with their earnings growth and share buyback activity, there is one other catalyst. It was recently announced that Procter & Gamble has plans to realign their global business to improve sales and reduce costs. PG recently brought back CEO Alan Lafley to refocus the company, and he has announced his goal to cut costs. This realignment comes after Lafley laid out a new strategy for the company in August. The new strategy focuses on strategic investments, cutting costs, and innovation. As the effects of these catalysts are combined with sales growth and increasing cash flow to buyback shares, Procter & Gamble will only become stronger.

As always, this article represents my opinions at the time of writing. You should do your own due diligence before making any decisions. However, I believe that Procter & Gamble represents a quality company that is trading hands at a discount.

Disclosure: I am long PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.