Procter & Gamble (NYSE:PG) is a US corporation whose diverse product mix is known around the world. It was first incorporated in 1905 and has grown to the point where it currently sells consumer packaged goods in 180 countries. Not only is Procter & Gamble's client base diversified geographically, they are also diversified across the 5 business units in which they operate. These units include:
Fabric and Home Care products
Baby and Family Care products
Procter & Gamble's closing stock price on Friday was $77.97. At that price, it sells for a PE (Price to Earnings) multiple of 20.94, with a dividend yield of 3.09%. That PE is looking pretty pricey for a slow growth company the size of Procter & Gamble. As I mentioned in an earlier Seeking Alpha article, which you can view by clicking Here, I expect consumer staples companies to get "squeezed" over the next couple years. The headwinds I see are two fold: igher input (raw material) costs and a consumer with little discretionary income (because of limited wage growth). Some have also suggested that a weakening of emerging market currencies will be a problem for these multinationals. I am not particularly worried about emerging market currencies, because large multinational companies (like Procter & Gamble) are skilled at managing these fluctuations. I needed to look at Procter & Gamble's valuation, because I have owned it for many years, and like to analyze my holdings every 6 months or so. So click the link above if you want to read about the headwinds these companies face, or keep reading if you want to my opinion of the current valuation.
Discounted Cash Flow Valuation
The primary method I use when valuing a company is its discounted future cash flow, although I will discuss several other important metrics below. I completed my valuation spreadsheet below using historical data from GuruFocus.com. Over the past 10 years, Procter & Gamble's earnings-per-share [EPS] and free-cash-flow [FCF] have been growing at fairly similar rates. My problem is that the growth rate has been fairly slow. Let's hope that the 2013 year end results will be a harbinger of things to come. There is hope that the new management is beginning to shake things up and get the company earning and growing again.
In the table below, I assumed the future earnings growth rate would match the average 10 year growth rate for the company. I used the lower of the EPS and FCF average growth rates because so many companies try to play games and goose their earnings numbers. I discounted the future earnings at a rate of 5% because, despite the Federal Reserve's ultra low interest rate policy, I fully expect the yield on treasury investments to rise in the coming years. A 2% premium over the 10 year bond seems low, but appropriate at the current time. Given all of those assumptions, Procter & Gamble appears to currently overvalued by about 4% ($78 vs $75).
I am a dividend investor at heart. While I love to find and buy undervalued companies, I really enjoy the passive cash flow that growing dividend streams provide. The 10 year average annual dividend growth rate for Procter & Gamble is 10.55%, and the 5 year average annual dividend growth rate is 8.72%. I ran my 50 year Discounted Dividend Analysis Model with a projected annual dividend growth rate of 8.72% (which is the lower of the 5 year and 10 year averages) and a discount rate of 10%. The present value of the next 50 years of dividends are $93.10 at the 10% discount rate and $64.22 at a 12% discount rate. I have some concerns that future dividend growth will be constrained by the current payout ratio (64%). These figures suggest to me that Procter & Gamble's shares are about fairly valued, when I take into account my concerns about the slowing dividend growth and the fact that this model looks into the future 50 years. It is difficult to say what the world will look like in 20 years, much less 50 years. Below is a chart, courtesy of Gurufocus.com, of the company's 10 most recent years of dividend growth.
I always look at any investment through the lens of its historical perspective. In keeping with that idea, below is how Procter & Gamble currently compares to its 10 year ranges:
The current dividend payout ratio is 64%, vs. a 23% minimum and 91% maximum
The current dividend yield is 3.09%, vs. a 1.64% minimum and a 3.57% maximum
The current PE ratio of 20.94 compares to a 10.46 minimum and a 25.34 maximum
The current Return on Equity of 16.60% compares to a 13.8% minimum and a 37.5% maximum
Courtesy of Morningstar.com
Cash Flow and Revenue Trends
I think the graphs above accurately show Procter & Gamble's struggle over the past few years. Until the most recent fiscal year, gross revenue slowly climbed, but net income and free cash flow struggled. Perhaps the recent management changes and the 2013 financials show the beginning of a bright new future, but I don't invest on hope.
Based on the information above, I will continue to hold my shares in Procter & Gamble, but will not be adding additional shares at this time. Perhaps at a notably lower price per share will change my mind. Even though the dividend yield looks acceptable, the PE and price-to-cash flow metrics are concerning. Equally concerning is the decline in the return on equity results over the last few years.
If you feel compelled to invest in the consumer staples space, perhaps an alternative company would serve you better. I purchased shares of Unilever (NYSE:UL) a month ago for the reasons outlined in the linked article. Additionally, I have compiled the table below, with data from Morningstar.com, which compares Procter & Gamble and several competitors. Perhaps it will be a starting point for your research and eventual investment in the consumer staples space.
Disclaimer: This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above is provided by Yahoo Finance, Gurufocus.com and Morningstar.com.
Disclosure: I am long PG, UL,GIS. I do not anticipate adding to these investments in the near term. 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.