Procter & Gamble: A Classic Investment With Great Potential

| About: The Procter (PG)

I've conducted an analysis on the Procter & Gamble Company (NYSE:PG):

PG maintained FY10 targets for 5-7% sales growth, operating margin expanded to 24% vs 19.4 in '06 and EPS growth of around 10%. The sales and operating margin goals suggest EPS growth of 13%-15%.

Gillette integration should produce upper end of $1.0-$1.2 billion in cost synergies. In the last six months, PG has increased Gillette’s distribution by 50% in China with the placement of its products in 70K new stores, and has increased Duracell’s penetration in Mexico to 90% from 55%.

Fusion is growing Gillette's share in Europe and Japan; the Phantom and Venus Breeze are soon to ship. PG reached one billion new consumers between 01 and 06, and plans to reach one billion more by '10.

PG's competitive strengths are a diverse portfolio of businesses, scale, strong brands and a strong focus on product innovation. Combined with geographic diversity, category diversity provides PG with a consistent revenue stream. With $68 billion in sales PG has the benefit of scale, which provides greater sales opportunities and cost savings compared to its peers.

PG invests over $200 million annually in consumer understanding, and interviews four million consumers a year.

These core strengths have created examples of what I think PG should continue to produce in the future. For example, in skin care, the Olay sub brands have been introduced with premium pricing and minimal cannibalization. Total Effects was targeted to women who want to repair skin damage; Olay Regenerist was targeted to women who take a regimented approach to skin care; and the new Olay Definity is target to women who also take a regimented approach, but who are concerned about the tone and texture of their skin.

PG’s debt increased by 56.6% to $38.10 billion at the end of 06, as a result, d/e ratio improved substantially from 1.39 at the end of 05 to 0.61 at the end of 06.

According to Goldman Sachs:

The stock is currently trading at a 36% premium to the market on FY07E – versus five and ten year averages of a 21% and 14% premium, respectively, and the HHPC large cap group at a 28% premium. The rich valuation is the key reason we are not more constructive on the shares.

Nonetheless, the fundamental story is compelling and we believe valuation is sustainable for now, given the healthy sales and volume trends as well as the macro backdrop of slowing GDP growth which is helping staples in general.

Our 12-month price target, derived using a blended PE and DCF analysis, is $68, implying 7% potential upside.

PG 1-yr chart

PG 1-yr chart