Procter & Gamble: Still Too Early To Lighten Up

Summary

• The company beats on both sales and earnings in Q2.
• We continue to see favorable tailwinds here.
• Remaining long.
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We have been long Procter & Gamble (NYSE:PG) since around the $76 level. A few weeks back, the company, announced its fiscal second quarter earnings. Results were good. Both the top and bottom line came in ahead of expectation. Revenues hit $17.44 billion which was almost $300 million higher than what the market was expecting. Furthermore, earnings per share of $1.25 was $0.04 better than the $1.21 number predicted.

These positive trends led the firm to increasing its guidance with respect to company organic sales for the full fiscal year. Second quarter results definitely showed that customers still will buy quality merchandise if the value is there. We especially saw this in its healthcare & fabric and home care business. We have been consistent in our belief that renewed focus was always going to come to the firm as a result of the 100 brands having being removed from the firm. Innovation now seems to be back at P&G. As long as the company can continue to improve significantly on its products, customers will keep coming back for more.

This is why we would not rule out a strong recovery in the grooming business. If sales can gain traction here, it would really move the top line as the grooming segment makes up around 10% of sales. New packaging and a new razor launch (for men with sensitive skin) are the near-term events in order to try and move the needle here. Obviously, the customer does not feel he is getting enough value for the price he is paying at present. A host of cheaper alternatives have taken significant market share in this segment over the past. P&G is on a mission to rectify this as soon as humanly possible.

Shares currently trade at just above the $98 mark. This is a 29% return excluding dividends on our position. Although probably fair valued at present, we have no intention of lightening up here just yet. Here are 2 more key points to back up our argument.

• Firstly, even though P&G's sales multiple has increased to almost 4, it is not the company's fault that the market continues to favor this stock. Situations like these is where the investor makes the unforeseen error of liquidating the position far too quickly. P&G's current sales multiple of 3.8 is both above the industry's average of 2.8 and P&G's 5-year average of 3.3. However, we have seen many stocks which have decided not to come down to their average valuations quickly. One stock which comes to mind is V.F. Corporation (VFC). Therefore, if P&G continues to post impressive numbers, we want to ride this wave as long as possible. P&G still has an impressive balance sheet and along with the generous dividend, aims to return a further $5 billion in share buybacks this year. Far too early to bail here in our opinion.
• Cash flow is another vital area especially for income-orientated investors. Why? Because cash pays the dividend and not earnings which many believe. P&G's free cash flow in the recent December quarter came in at $3.3 billion. This is the highest number this key metric has been over the past 10 quarters. We like how free cash flow gets protected, for example. In Q2, there was more debt issued than paid back. Furthermore, share repurchases were below average at about $751 million. These measures were utilized to offset the larger than normal $3.8 billion of spend within the investing section. Remember P&G has an excellent debt to equity ratio of 0.41. The company will sporadically borrow more or buy back less stock to fund acquisitions and investments. From a shareholder's point of view, this is fine as long as free cash flow is being protected.

Therefore to sum up, we believe Procter & Gamble is still well worth its forward earnings multiple of 22. Sentiment is not ultra pessimistic and we see further gains here. Furthermore, it now looks highly likely that stocks put in a 4-year cycle low last December. Further gains both in the indices and P&G should be on the cards here.

Analyst’s Disclosure: I am/we are long PG. 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.