- We take a close look at Procter & Gamble’s strengths and weaknesses in this article.
- Its cost structure, inventory efficiency and growth potential are weighed up.
- We also compare it to a sub-industry peer and find that Procter & Gamble appears to offer better value for money.
In this article, we're focusing on Procter & Gamble (NYSE:PG) and assessing its strengths and weaknesses in comparison to Estee Lauder (NYSE:EL). While the two companies are of very different sizes, with Procter & Gamble having a market cap of $226 billion and Estee Lauder's being just $29 billion, we think a comparison of the two stocks could prove to be useful and worthwhile. That's because we appreciate that a lot of investors apportion their capital based on GICS sectors and GICS sub-industries. Indeed, Procter & Gamble and Estee Lauder both sit in the same GICS sector of consumer staples, as well as the same GICS sub-industry of personal products. We hope you enjoy the article and look forward to reading your comments below.
A key area for us when it comes to consumer products companies is how well they can keep costs down over the long run. Sure, it's one thing increasing revenue, but if your cost base also is increasing at the same rate, then it does little to aid the bottom line. So, looking back at the last 10 years, we're impressed with how well Procter & Gamble has been able to keep a lid on its cost of goods sold figure. Nine years ago, it was equal to 49% of revenue and, although it has increased during the period, it is currently only slightly higher at 51.1% of revenue.
While a slight uptick is disappointing, we're pleased to see that Procter & Gamble's cost of goods sold figure is very consistent, with it occupying a narrow range during the period. For instance, it has been as low as 48% and no higher than its current level during the period, which gives us confidence that the company will be able to keep it at around the 50% level moving forward.
Meanwhile, Estee Lauder has been able to go one better than its sub-industry peer. Not only is its cost of goods figure much lower than Procter & Gamble's, at 19.7%, it has fallen significantly over the last ten years. Indeed, it was 25.5% in 2005 and has steadily dropped during the last few years. This has had a positive impact on the company's margins and appears to be on a positive trend, which bodes well for the future.
Changing Inventory Levels
We're also keen to focus on the two companies' inventory levels. Sure, consumer goods companies need large amounts of inventory on hand, but we're slightly concerned to see that Estee Lauder's days inventory on hand level is fairly high and, perhaps of more importance, it has risen significantly over the last nine years. For instance, it was 160.4 in 2005 and has risen over the period so that it now stands at 203.6.
This does not compare favorably to Procter & Gamble's equivalent ratio, which currently stands at a much lower 58.8. In addition, Procter & Gamble's number has fallen steadily from 61.7 in 2005 to the present level. Unlike Estee Lauder, this shows that Procter & Gamble is being highly efficient when it comes to its inventory levels and is, therefore, not tying up anywhere near as great a proportion of working capital in inventory. For us, excess inventory represents a drain on cash that could be better deployed elsewhere, so we're keen to see days inventory on hand numbers stay as low as possible over the long run.
Looking ahead, Estee Lauder seems to have the stronger growth prospects of the two companies. However, that's not to say that Procter & Gamble is a slouch when it comes to bottom line growth potential. For example, it is expected to increase EPS by a highly impressive 18.9% in the year to June 2015, while the following year is due to see further improvements in profit to the tune of 7.8%. Both of these figures are very respectable and show that Procter & Gamble, as well as being efficient when it comes to inventory levels and costs, has strong growth potential.
Despite this, Estee Lauder looks set to post the better growth numbers going forward. It is forecast to increase its bottom line by 15.2% in the year to June 2015 and by 19.5% in the following year. This means that, in just two years' time, Estee Lauder's earnings are set to be 37.6% higher than they were in the year to June 2014 (versus 28.1% for Procter & Gamble). That's strong growth indeed.
Despite its weaker growth prospects over the next couple of years, we think that Procter & Gamble offers the better value of the two companies right now. For example, it currently trades on a forward P/E ratio of 17.4 versus 21.2 for Estee Lauder. Sure, the latter has better growth prospects over the next two years, but we think that the current gap between the two companies' P/E ratios is too wide. Furthermore, looking further out highlights that Procter & Gamble could be the better buy, with its five-year PEG ratio being 2.1 versus 2.5 for Estee Lauder.
In addition, while the two companies have the same price to sales ratio of 2.7, Procter & Gamble has a lower price to book ratio of 3.3. (Estee Lauder's is 7.6). As a result, we think that Procter & Gamble could outperform its sub-industry peer moving forward.
Despite its near-term growth rate in earnings set to be below that of its sub-industry peer, we feel that Procter & Gamble could outperform Estee Lauder. We're impressed by its consistent cost base over the last 10 years, and also how efficiently it utilizes its working capital when it comes to inventory levels. This is in contrast to Estee Lauder, which uses up a relatively large amount of working capital when it comes to inventory levels.
We're also impressed with Procter & Gamble's growth potential, although concede that Estee Lauder's is slightly stronger, but note that Procter & Gamble's current valuation appears to be unjustly low relative to its peer - even when differing growth rates are taken into account. As a result, we believe that Procter & Gamble could outperform its sub-industry peer moving forward as the market moves to correct what appears to be a mispricing by bidding up shares in Procter & Gamble going forward.