Procter & Gamble's (NYSE:PG) shares saw some pressure following a downgrade from analysts at Wells Fargo. There is nothing shocking to the analyst update, which has simply revised the fair valuation range downwards by three dollars.
I remain a long term buyer on dips in this great business which pays solid dividends and has a great track record.
Wells Turns Cautious
Analyst Chris Ferrara of Wells Fargo has downgraded his rating on Procter & Gamble from outperform to market perform. At the same time, Ferrara has lowered the fair value range by three bucks from $88-$90 per share towards $85-$87 per share.
The reason for the more cautious stance is the slower progress being made on the back of competition and "vulnerable" launch activity. While P&G is focusing on innovation again, its competitors appear to counter its efforts by aggressive price cuts.
Despite the increased innovation and new product launches, US market share trends are seen weaker amidst tough competition, according to Ferrara.
Therefore, fourth quarter results have the potential to disappoint, which makes it difficult for shares to outperform. Procter & Gamble is expected to reports its fourth quarter results on the 1st of August.
Ferrara has lowered his earnings estimates for 2015 and 2016, but the adjustment made to earnings estimates is negligible. 2015 earnings are seen a penny lower at $4.47 per share, while 2016 earnings estimates have been reduced by two cents to $4.89 per share.
Last month, Procter presented at the Deutsche Bank Global Consumer Conference. The company stressed the encouraging trends with third quarter organic sales increasing by 3% while core earnings were up by 5%. In constant currencies, core earnings would have been up by 17%.
The key focus remains on the creation of value for shareholders after years of underperformance. The company aims to do so by growing sales, improving its margins and improving the asset efficiency. The resulting profit growth and cash flow growth should allow Procter & Gamble to return more cash to investors.
The company aims to do this by focusing on its core operations, developing markets, while effectively managing its brand portfolio. A return to Procter's innovative strengths should boost sales growth, while productivity should allow for the increase in margins combined with a simplification of its manufacturing base, thereby boosting gross margins.
The shift to mobile and social advertising and a focus on improved advertising and marketing efficiency should allow the company to lower its selling, general & administrative cost base.
Valuing The Business
Back in April, Procter released its third quarter results. The company ended the quarter with $8.2 billion in cash and equivalents, while it has another $1.6 billion in investment securities held for sale.
Total debt stood at $35.4 billion which results in a rather steep net debt position of little over $25 billion. Noticeable as well, of this total debt position some $15.5 billion matures within a year.
On a trailing basis, Procter & Gamble posted revenues of $84.7 billion with revenues being stagnant at the moment. Trailing earnings stood at $10.9 billion after the company took modest $308 million in operating charges during the year. At $81 per share, the equity is valued at $219 billion which values operations at 2.6 times sales and roughly 20 times earnings.
Procter's appealing $0.6436 quarterly dividend provides investors with a 3.2% dividend yield.
Looking Back At The Past Performance
Procter & Gamble has grown revenues at an average rate of about 6% between 2005 and 2013, with growth of course being driven by the 2005 acquisition of Gillette. Ever since this big deal, revenues have only grown at a rate of 1-2% per annum.
Note that earnings grew from $6.2 billion ahead of the Gillette deal to peak at $13.4 billion in 2009. Earnings have been falling in recent years towards $11 billion as the company has failed to grow revenues in a meaningful way, innovation has lacked, and bureaucracy has grown in the organization.
While Procter saw its share base increase following the Gillette deal, the total outstanding share base has been roughly flat over the total time period following share repurchases in recent years.
It has been a year since formerly retired CEO Lafley re-joined the company in order to rejuvenate innovation, sales growth and recover margins. Despite his return, shares have been flat over the past year, while they have not gained any ground as well so far in 2014.
In his defense, Procter has accelerated organic growth, but currency depreciation and the sale of non-core businesses are the reasons why the company could not report an increase in reported revenues.
While the headline results don't necessarily show the underlying strength, the company surely is showing underlying strength as witnessed by organic sales growth rates.
Lafley is ahead of schedule as well by reducing the total headcount to save costs, so far having cut 8,750 jobs. Combined with manufacturing and marketing rationalization efforts, a cumulative $10 billion in cost savings are targeted by 2016.
The focus on growing top-line sales and efforts to boost margins should be able to drive earnings towards $13-14 billion, which still results in a 16 times earnings multiple going forwards. Yet the very strong track record of the business makes this acceptable in this low interest rate environment.
Remember that Procter has solid diversification with 25 brands bringing in more than a billion in annual sales. It has furthermore a track record of 58 years of consecutive dividend increases.
However, these improved earnings are still not a reality, the reason why Lafley has resorted to high shareholder payouts in the meantime. On top of the dividend yield, which is still comfortably above 3%, it spends a lot of cash to repurchase its stock, returning roughly 6% of its market capitalization per annum back to investors.
This means that I like the stock, especially on a long term horizon. I remain a buyer on dips, like the one witnessed in February when shares fell back towards $75 per share.
Around the $70-$75 level, I would be triggered to buy. Investors should not read too much into Wells Fargo's more cautious stance as a penny or two adjustment to earnings is negligible.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.