Company Analysis - Procter & Gamble (PG)

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Firm overview

The Procter & Gamble Company (P&G), incorporated in 1905, is focused on providing consumer packaged goods. The Company’s products are sold in more than 180 countries primarily through mass merchandisers, grocery stores, membership club stores, drug stores and high-frequency stores, the neighborhood stores, which serve many consumers in developing markets. It has on-the-ground operations in approximately 80 countries. As of June 30, 2010, P&G comprised of three Global Business Units (GBUs): Beauty and Grooming, Health and Well-Being and Household Care. Sales to Wal-Mart Stores, Inc. and its affiliates represent approximately 16% of its total revenue during the fiscal year ended June 30, 2010 (fiscal 2010). In August 2009, AnimalScan, LLC announced that it has acquired Iams Pet Imaging (IPI), LLC from The Procter & Gamble Company and ProScan Imaging. In October 2009, Warner Chilcott Plc completed the acquisition of the Company’s global branded prescription pharmaceutical business. In July 2010, Sara Lee Corporation completed the sale of its air care business to The Procter & Gamble Company.   Source: Reuters

Investment rationale

Investment rationale includes based on a P/E basis, the firm appears undervalued given forecasted growth, business risk, and financial risk.  When several metrics are looked at, the firm appears to benefit from a durable competitive advantage.  The firm has a strong dividend that appears, for the time being, to be sustainable.  Current dividend yield is 3.10%.  The current dividend provides downside protection, while providing a steady growing stream of income to income oriented investors.  The firm generates cash from operations and has a strong balance sheet.  The firm has strong margins that appear to be growing into the future as the firm's management seeks out operating efficiencies.  Given historical long-term growth and current trends in margins, the firm appears undervalued from both a risk-adjusted P/E and DCF basis.

Highlights

• Firm has strong gross margins.  Margins are >40% indicating durable competitive advantage.  Net profit is slightly <20%; net profit >20% indicates durable competitive advantage.  Growing margins indicate strength.  Firm seeks higher margins through operational improvements and efficiencies.
• Firm has strong liquidity position.  Free cash flow productivity is greater than 90% for all periods analyzed; this ratio indicates the firm generates 90% of net income into free cash flow.  Current ratio is <1; companies with a durable competitive advantage typically do not need a current ratio >1.  Firm has $11 billion credit facility that is a back-up for commercial paper issuance; commercial paper can be used to fund any short-term needs.
• Firm has strong balance sheet.  Debt-to-total capital ratio is below 50%; this level indicates firm is not overlevered.  The firm has a debt-to-equity adjusted for common shares of 20%; this is well below 80%.  An 80% level for this ratio indicates the firm has a durable competitive advantage. 
• Firm is efficient with capital.  ROCE is lower than it was 10 yrs earlier; primary cause is acquisition of Gillette, but ROCE is increasing each year.  Financial leverage index (=ROCE/ROA) is above 2 for each year analyzed indicating effective use of leverage.  The return on unlevered net tangible assets (Warren Buffett's ratio) increased each year and is over the 25% threshold.
• Current dividend payout ratio is under 50% allowing for future growth in the dividend.  Dividend grew at 11%, while total net profit grew at 17%.  Firm has ability to increase the dividend payout ratio.

Valuation

		Risk-adjusted discount rate
	Growth	8.8%	9.8%	10.8%	11.8%	12.8%
Downside	5%	$73.91	$62.78	$54.51	$48.12	$43.05
Base	9%	$95.39	$79.76	$68.23	$59.41	$52.47
Upside	11%	$108.89	$90.42	$76.84	$66.49	$58.37

Based on a risk-adjusted discount rate of 10.8%, the intrinsic value of PG is $68.23 per share.  Currently, this is 9.7% above where shares are currently trading.  The risk-adjusted margin of safety is 12.9%, or the appropriate purchase price is $59.40 per share.  The suggested market price is approximately $2.70 above where it is currently trading.  If there is a sell-off in the stock where it is somewhere in that range, I would purchase the shares.  In addition, the firm indicates a buy with a forward P/E of 14.22.  This is below the "Buy P/E" calculated; the "Buy P/E" is calculated at 19.85.  Given the expected 9% growth rate in addition to less risky business and financial profile, PG should trade at a premium.  As indicated earlier, the stock has a strong dividend.  Given the discount to its intrinsic value and adequate dividend yield, it would be prudent to buy PG on a selloff.

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This information is for educational purposes only, and the opinions expressed do not constitute a recommendation to buy or sell. Author may have a position in the companies discussed, subject to change at any time. Information on this website obtained from reliable sources, but there is no guarantee of accuracy. Please consult your financial advisor before making investment decisions. Past performance is not indicative of future success.