Procter & Gamble Co. (PG) moves up and down slowly and the defensive stock has steadily climbed for the last three years in this tumultuous environment. Since the stock moves slow, it takes three to four months between highs and lows, but the stock slowly keeps growing. It is about time for the stock to start another bearish move in the long-term bullish trend. Let's take a look where the stock is presently and why it will end up turning down soon.
An Uneventful Fourth Quarter
The company's fourth quarter was uneventful, like most companies this time around. Earnings beat estimates as analyst expectations of 77 cents per share were overshadowed by PG's 82 cents. This year, the company has been involved in (and still is) cost-cutting measures that include product price cutting and operational costs. Even though these activities helped with the bottom line, revenue short falls and rising commodity costs neutralized any savings. Revenue declined by 1% with help from currency exchanges also. The commodity problem will continue to hurt company margins on top of sluggish European and American economies.
Price Cuts - Finally
On the bright side, it reported an increase of 45 percent for its net income for the fourth quarter. I believe the thing that made this happen is what Bank of America may referred to when it wrote about macro environments not looking so damaging. Procter & Gamble has been involved in sales and price-cutting measures as of late. It saw a boost in sales when it sold off its Pringles snacks business.
Even though it beat earnings expectations, in the present time period (July- September), it is expecting a 4 to 6 percent decline in revenue, while sales continue to decline with wider market share being given up. Yet in 4Q, market shares have picked up after the price cuts for major products. Some of the larger products like Tide and Gillette have received price cuts. It is expected to further lower prices for the entry-level-priced versions of other products like Bounty paper towels and Charmin toilet paper to recover market share.
It plans to execute further such price cuts for other beauty and personal care products to recover lost market share from competitors like Unilever, Kimberly-Clark and Colgate-Palmolive.
One can logically conclude that if cost constraints exist, cost-cutting measures will also have to come into play. With commodity prices rising, P&G set a target to cut $10 billion in costs. This includes $1 billion in marketing and $3 billion in general overhead expenses. When raising prices did not work and competitors started to steal market share, P&G had to reverse direction and cut back prices. It will be giving back about $400 million of the increases this year, (twice as was projected). So we have a good reason for the company to be frugal and streamline the business with cuts.
Analysts and Fund Holders have an Interest in the Stock
Bill Ackman recently bought 22 million shares of Procter & Gamble. The value-oriented hedge fund, Pershing Square Capital, has about $10 billion under management and Mr. Ackerman is pressing PG management to speed up restructuring and cost cuts to show a turn around for his investors. Bank of America reiterated its Buy rating on Procter & Gamble and increased its price objective from $67 to $71. Besides the activism of Mr. Ackerman, the macro environment does not look damaging anymore, as it did when price increases were not followed by competitors. Between a steadily movement higher and savings from cost-cutting measures, the company is starting to look healthy, according to the bank.
I need to point to a weekly chart first (above), since this gives us the greatest understanding of how this stock has moved. Considered a defensive stock, it has consistently and slowly moved up through our tumultuous economic cycle. For the last two-and-a-half years, we have a very well defined (mildly-bullish) peak-and-valley pattern. The economic atmosphere is still favorable for stocks like Procter & Gamble. As I read about the economy, I am of the opinion that things won't change much in 2013. For this reason, I would expect the same pattern to develop.
Since we have looked at the weekly chart above, let's go to the daily chart (below) now to see where it is going. The thicker green lines on the chart are the long-term trading channel we observed in the weekly chart earlier. Presently it is at the top of this pattern and I expect it to take a turn down eventually. Since this is a slow and steady moving stock, it is not uncommon for it to stay at this level for up to six weeks before it starts to really move down. For this reason, I cannot say when it will take a turn down - but it will. If I am going to create an income play here, it will lean to the bearish side and I will need plenty of time for decay in case the stock continues in the same pattern it has now.
The Options Play
The stock is presently trading at $66.97. I am looking for at least five months time-decay protection here. I also would like to buy the first option (in the money).
- Buy the January 2013 put with a strike of '67.50' (priced at $3.25)
- Sell the January 2013 put with a strike of '65.00' (priced at $2.02)
- Net Debit to Start: $1.23
- Maximum Profit: $1.27
- Maximum Risk: Net debit
- Maximum Length of Play: 5 months