Procter & Gamble Fits Profile Of Stock We Want To Own In Preparation For Hard Times

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About: The Procter & Gamble Company (PG), Includes: KHC
by: Zoltan Ban

Summary

Given a number of indicators such as economic as well as geopolitical events around the world, it is reasonable to expect the current economic expansion cycle to end soon.

We are within or close to the window of opportunity to start gradually shifting towards defensive stocks. Procter & Gamble fits the profile.

Its P/E ratio is higher compared with some alternatives, while its dividend is less generous, but it is showing improving profitability, which makes it a good potential candidate.

As I wrote in a recent article, given all that is going on in the world, I personally find it wise to start looking at defensive stocks as a way to start preparing for harder times ahead. I by no means think that there is a great deal of urgency to this. It is nevertheless important to start looking at what the best options might be in this regard, because I do think that there are enough signs out there to suggest that we are now in a very late stage in this already very long global economic recovery. I already analyzed Kraft Heinz (KHC), which I believe has quite a bit of potential to be a good bet in the face of coming hardships. Now, I want to look at Procter & Gamble (PG) which has a different product lineup, as well as a different investment profile, from a financial point of view.

The global economic outlook

As things stand right now, there are some glimmers of hope that an all-out economic war fought between the world's two heavyweights might be avoided. China announced its determination to open China up to more global imports of goods, as well as a better investment environment for foreign firms, potentially serving as a basis to defuse current trade tensions. On the other hand, it may be mostly talk, with no clear steps taken in this regard. Other than that, we are getting ever closer to a no Brexit deal scenario, which could rattle the EU economy, as well as the world. Italy's budget confrontation with the EU is intensifying as well. The two conflicts may provide for a one-two punch against Europe's economic, political, and social well-being. Meanwhile, EU elections are coming up and the scene looks increasingly polarized, giving rise to the possibility that the new EU parliament will become paralyzed. On a positive note, the Iran oil import waivers are making it less likely that we will experience an oil price spike, although we will have to see whether we will not revisit this problem six months from now when those waivers expire. Other than that, the EU economy is in slowdown mode, with the US economy also facing a slowdown next year, as the effects of the tax cuts start to wear off. In my view, this all points to very low odds of an actual full-blown economic crisis in the early part of next year, but beyond that, it is starting to look grim.

Procter & Gamble has a recession-resilient product lineup

With products such as Tide, Bounty, Charmin, Crest, Dawn, Always, it is hard to see how this company could suffer much in the face of a recession. These are all products that consumers cannot easily give up on, even in the event that times will get tough. There can be some product substitution, for instance, Bounty paper towels may be substituted with cheaper alternative paper towel brands. I don't believe that the substitution effect for most of its products would ever become so significant that it would cause a severe decline in revenues or profits.

Latest financial results

Unlike the price of Kraft Heinz stock, which currently is off by about 45% from its all-time highs, Procter & Gamble stock is within about 2% from its all-time highs. One of the main reasons is that, as I pointed out, Kraft Heinz profits have been in decline, while Procter & Gamble is seeing the opposite happen as its latest quarterly report shows. In fact, its net earnings are up 12%, even though its revenue has been flat for the latest quarter, compared with the same quarter from last year. In terms of profitability as a percentage of revenue, it is looking rather solid, with $3.2 billion in net earnings, on revenue of $16.7 billion. Other important measures such as interest on debt are looking good as well. Interest costs came in at $129 million, which is less than 1% of revenue.

Procter & Gamble versus Kraft Heinz dilemma

While there is no contest about Procter & Gamble having produced better results lately, I think there are nevertheless some downsides to choosing it over Kraft Heinz. My starting point in this regard has to be the dividend. Kraft Heinz currently offers a dividend of about 4.65%, while Procter & Gamble only offers 3.2%. If, for instance, we have a time-frame of five years in mind when choosing the best investment, Kraft Heinz will pay out dividends equivalent of 23.25% of the investment value, while Procter & Gamble will only pay out 16%. In other words, Procter & Gamble stock would have to outperform Kraft Heinz stock by over 7% during the period, just to make up for the lower dividend. I am not including the dividend reinvestment effect in this calculation, just to keep things simple, but that too would increase the gap that Procter would have to make up through stock price gains.

If the better financial performance trends were to hold, it would of course be quite possible for Procter & Gamble stock price performance to more than make up for the smaller dividend. Having said that, Kraft Heinz also reported for the latest quarter since I wrote my article on it, and there is something that I find rather intriguing. Net earnings are down 33% compared with the same quarter from last year, which is what has been dragging the stock price down. At the same time, revenues are up 1.6%, for the same period. I personally think that the slide in profits will pass for Kraft Heinz. At the same time, with flat sales, Procter & Gamble can only take profitability growth so far. In other words, its gains in profitability will end and could even see a reverse, while Kraft Heinz could see the opposite happen going forward, while there also seems to be some room for revenue growth.

Considering the likelihood that both Procter's profitability improvements and Kraft's loss of profitability are baked into their respective stock prices, it is hard to conclude that simply based on Procter's recent profitability improvements versus Kraft's deterioration on the same front will necessarily translate into far superior stock performance for Procter & Gamble, relative to Kraft Heinz. It could indeed be the case or perhaps not. Therefore, as far as I am concerned, it presents investors with a dilemma. It is not a dilemma that can be resolved by simply looking at P/E ratios either. Kraft Heinz has a P/E ratio of 6.3, while Procter & Gamble's P/E ratio is 23.75. Of course, the big discrepancy is due in large part because the first has declining net earnings, while the other is seeing improving net earnings. The P/E ratio of Kraft is only favorable if we will see the decline in profitability stemmed and hopefully reversed soon. In that case, there may be some significant upside. On the other hand, if there is a slump in Procter's profitability improvements, its P/E may all the sudden make its valuation seem too rich.

As I already pointed out, there is no rush to jump in just yet. I will continue covering defensive stocks, from different sectors in coming months, which helps with my own research in regards to what might be the best stocks in the event that we might be faced with a global or regional economic downturn soon. My goal is to start building a position in defensive stocks gradually, starting soon and continuing on mostly next year. I am not overly concerned about the timing, because I think both stocks have limited downside at this point, while both of them pay while one waits in the form of a decent dividend. I am therefore not overly concerned about moving too early. I will most likely choose two or three defensive stocks in the end, and thus far, I think both Procter & Gamble and Kraft Heinz have good potential.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.