Procter & Gamble (NYSE:PG) is the owner of some of the most recognizable household brands. It also holds one of the most diversified product portfolios. P&G's stock performance maintains a "slow and steady wins the race" feel, making it a stalwart of many portfolios. 2012 was a substantial year for P&G as they announced a large cost reduction effort hoping to cut $10 billion in 5 years. Later in that same year, famed hedge fund activist Bill Ackman brought P&G back into the spotlight as his company, Pershing Square, bought a significant stake in P&G. His plans were to unlock shareholder value by making changes to upper management and continuing to drive cost cutting measures. Fast forward to present day and you will see that Pershing Square has been reducing its total holdings of P&G after seeing a gain of 38%. This reduction in total holdings made me curious as to whether or not P&G has much, if any, upside remaining.
The recent earnings call did not excite many investors. Where there was good news, it seemed to be offset by bad news but at a higher magnitude. FX and "negative geographic and category mix" were pinned as impeding the cost reduction effort, which led to margin contraction. Specifically, a 130 basis point cost reduction was offset by a 130 basis point impact from "geographic and category mix" as well as a 90 basis point negative impact from FX. One step forward two steps backward.
P&G did make positive strides in reducing SG&A relative to sales, which can be seen over the past few quarters in the table below which I calculated from the Income Statement:
They attributed this reduction to: "…an optimized media mix, with more digital, mobile, and social presence, improved message clarity, and greater non-advertising marketing efficiencies." It is showing the ability to more efficiently invest marketing dollars to generate revenue. This is important from a company which relies heavily on marketing.
I created four scenarios for P&G to understand what its stock price "should" be if each scenario played out. The prices for each scenario were created with the Discounted Cash Flow Method based on the following assumptions:
- WACC: 6.38%
- Effective Tax Rate: 21.6%
- Free Cash Flow Productivity: 90% (from earnings call)
- Free Cash Flow Perpetual Growth Rate: 2% (beyond 2015)
- FY 2014 and FY 2015 revenues come in at expectation
Below is a description of each of the four scenarios:
- The negative 220 basis point impact from FX and "negative geographic and category mix" remains indefinitely, and P&G actually loses the cost reduction it has witnessed so far moving forward.
- P&G continues to have a negative 220 basis point impact from FX and "negative geographic and category mix", but maintains the already witnessed cost reduction moving forward.
- P&G no longer sees the negative 220 basis point impact, and maintains the already witnessed cost reduction moving forward.
- P&G no longer sees the negative 220 basis point impact, maintains the already witnessed cost reduction moving forward, and sees an even greater reduction in SG&A as a percent of sales, flat-lining at 29% in 2015 and beyond.
The table below shows the stock price under each corresponding scenario:
The upside to P&G is not earth-shattering, and most rational investors would not expect huge upside with P&G. The emphasis should be on the minimal downside. Essentially,the market is expecting negative impacts of things like FX and geographic and category mix to persist, and the cost reduction momentum to evaporate. If P&G manages to show that one element from the prior sentence is not true, then it should see price appreciation.
As with any stock, it is important to evaluate whether or not it meets your investing requirements. Based on the various scenario valuations and the 10 year PE/PB ratio graph below, it is extremely difficult to label P&G a value stock.
As one can see, both the PE and PB ratios are not exactly near historic lows, or for that matter really in the territory of a value stock. Therefore it is tough to buy such a stock on the principal of value. However, if a stock which sports a 3.1% dividend yield and a potential 17.9% upside with a fairly minimal downside satisfies your investing appetite, then P&G just may be the stock for you.