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Summary

  • In the latest instalment of our Head-To-Head series, we pitch two companies from the consumer goods sector, Procter & Gamble and Kimberly-Clark, against one another.
  • The article focuses on the relative strengths and weaknesses of Procter & Gamble and Kimberly-Clark based on business performance and sustainability/dividends.
  • It concludes by discussing the current valuations of the two companies, and answers whether Procter & Gamble represents good relative value at current price levels.

Procter & Gamble Background

Procter & Gamble (NYSE:PG) was founded in 1837 and is based in Cincinnati, Ohio. The company operates through five segments: Beauty, Grooming, Health Care, Fabric Care and Home Care, and Baby Care and Family Care. The Beauty segment offers cosmetics, personal cleansing, skin care and hair care products under the Head & Shoulders, Olay, Pantene, SK-II, and Wella brand names. The Grooming segment provides blades and razors as well as pre- and post-shave products under the Braun, Fusion, Gillette, Mach3, and Prestobarba brand names. The Health Care segment offers feminine care and incontinence products; toothbrush, toothpaste, and other oral care products. This segment markets its products under the Always, Crest, Oral-B, and Vicks brand names. The Fabric Care and Home Care segment provides bleach and laundry additives, fabric enhancers, and laundry detergents; and sells its products under the Ace, Ariel, Dawn, Downy, Duracell and Febreze brand names. The Baby Care and Family Care segment offers baby wipes, diapers, paper towels, tissues and toilet papers under the Bounty, Charmin, and Pampers brand names.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We score each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. 5 year average yield

Once we have scores for the two buckets, we can then assess whether a company represents good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price to sales ratio
  5. 5 year price to earnings growth ratio

So, for example, a company that scores well compared to its rival on the first two buckets (business performance and sustainability/dividends) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below highlights the data that we will use to score Procter & Gamble and Kimberly-Clark (NYSE:KMB) for the first two buckets.

Stock

Procter & Gamble

Kimberly-Clark

Business Performance

  

Return on equity

16.01%

44.72%

Return on assets

7.34%

10.83%

Operating margins

19.57%

15.90%

Quarterly rev. growth

-0.20%

-0.80%

Quarterly EPS growth

1.70%

1.30%

Sustainability/Dividends

  

Debt to equity ratio

51.92%

139.90%

Interest cover

19.59

11.27

Dividend payout ratio

65.00%

59.00%

Forward dividend yield

3.20%

3.00%

5 year average yield

3.30%

3.70%

We then score each company relative to its peer based on the above data, with points being awarded as follows:

1st place: 10 points

2nd place: 0 points

Below are the scores for Procter & Gamble and Kimberly-Clark:

Stock

Procter & Gamble

Kimberly-Clark

Business Performance

  

Return on equity

0

10

Return on assets

0

10

Operating margins

10

0

Quarterly rev. growth

10

0

Quarterly EPS growth

10

0

Sustainability/Dividends

  

Debt to equity ratio

10

0

Interest cover

10

0

Dividend payout ratio

0

10

Dividend yield

10

0

5 year average yield

0

10

Total Score

60

40

As you can see, Procter & Gamble beats Kimberly-Clark by a score of 60 points to 40 points. Indeed, we're impressed with the consistency shown by Procter & Gamble. Even where it was beaten by Kimberly-Clark in areas such as return on equity and return on assets, the scores posted by Procter & Gamble are still very impressive. For example, its return on equity, although not as high as Kimberly-Clark's, is 16.01%, while its return on assets is 7.34%. Both of these numbers are highly impressive and show that Procter & Gamble continues to be able to deliver high levels of profitability. Furthermore, the company only narrowly lost out to Kimberly-Clark in terms of its payout ratio (59% versus 65%) and we believe there continues to be scope for an increase in the payout ratio at Procter & Gamble.

Meanwhile, growth in the sector remains below what investors are hoping for, although Procter & Gamble's quarterly top and bottom-line growth rates remain slightly better than its peer. Both companies could be aided by improvements in the Chinese macroeconomic outlook, where recent PMI data has shown an expansion for the first time in six months, since consumer goods in emerging markets present a major opportunity for them. This could prove to be a catalyst for both companies over the medium to long-term and could help them to post improved top and bottom-line growth numbers going forward. For example, Chinese PMI data came in at 51 for the month of June - the highest in six months, while the economy continues to grow at an annualized rate of 7.4% according to first quarter GDP figures. With 39% of Procter & Gamble's sales coming from developing markets in 2013, macroeconomic improvements in the emerging world could make a big impact going forward.

In terms of sustainability, Procter & Gamble is the clear winner. Its debt to equity ratio is moderate at 51.92%, while Kimberly-Clark carries a larger amount of balance sheet risk as its 139.90% debt to equity ratio shows. To back up this point, Procter & Gamble's interest cover of 19.59 should allow the company to cover interest costs even when interest rates begin their long, upward movement as early as 2015.

Overall, we feel that Procter & Gamble is the clear winner here. It was close to Kimberly-Clark in many of the areas in which it lost out, and was significantly ahead in many others.

Valuation

So, we feel that Procter & Gamble has performed very strongly in the first two buckets and, as such, should trade at a premium to its sector peer, Kimberly-Clark. Let's see if it does.

Stock

Procter & Gamble

Kimberly-Clark

Valuation

  

Forward price to earnings ratio

18.01

17.15

Price to book ratio

3.22

9.10

EV/EBITDA

12.58

11.42

PEG

2.31

2.68

Price to sales ratio

2.59

2.01

While Procter & Gamble does trade at a premium to Kimberly Clark in terms of the forward P/E ratio, EV/EBITDA ratio and price to sales ratio, the premium is not as large as we would anticipate. For example, Procter & Gamble trades at a premium of just 5% to Kimberly-Clark in terms of the P/E ratio and at a premium of just 10.2% in terms of the EV/EBITDA ratio. Furthermore, Procter & Gamble trades at a discount to Kimberly-Clark when it comes to the PEG ratio and price to book ratio. This highlights the superior growth potential of Procter & Gamble, since a higher forward P/E has been more than offset by greater potential growth. In addition, the price to book ratio indicates superior value at Procter & Gamble, with it being 3.22 versus 9.10 for Kimberly-Clark. So, we believe that current valuations do not fully reflect the difference in quality identified by the first two buckets. Therefore, we feel there could be scope for Procter & Gamble to outperform Kimberly-Clark going forward.

Conclusion

Procter & Gamble is a high quality company that we believe offers good value at current levels. It scored highly on the Team Money Research rating system, beating its sector peer, Kimberly-Clark, by 60 points to 40. It also appears to be relatively undervalued at current levels since it trades at a discount on two of our five valuation criteria and a smaller premium than we would expect on the other two ratios. As such, we feel it could outperform its sector peer going forward.

Feedback Request: What do you think about Procter & Gamble? Would you buy, sell or hold right now? Please comment below!

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.

Source: Head-To-Head: Can Procter & Gamble Outperform This Rival?