Procter & Gamble: A safe place in a troubled environment?
Through its 185 years of existing Procter & Gamble has survived several recessions, depressions, market crashes, wars and whatever else that have happened since 1837. Yet, the company is still alive and well, and has significantly outperformed the S&P 500 in 2022. Thus, Procter & Gamble could be a stock to invest in as we expect some macroeconomic headwinds in the near future. In this analysis, I will investigate if now is the time to buy Procter & Gamble.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that the time of writing this analysis, I do not own shares in Procter & Gamble or in any of their direct competitors. If you want to copy the portfolio or want to see which stocks I hold, you can read how to do so here. I have no skin in the game when it comes to Procter & Gamble, meaning it shouldn't be hard to keep this analysis unbiased.
Procter & Gamble in an American company that was founded in Cincinnati, Ohio in 1837. Procter & Gamble provided branded consumer goods worldwide, and their products can be bought in more than 170 countries. They have ten products categories that are divided in five different segments. The five segments are: Fabric & Home care (35 % of net sales), Baby, Feminine & Family care (25 % of net sales), Beauty (18 % of net sales), Health Care (14 % of net sales), Grooming (8 % of net sales). Their largest market is North America (49 % of net sales) followed by Europe (21 % of net sales), Greater China (10 % of net sales), Asia Pacific (8 % of net sales), Latin America (6 % of net sales), India, Middle East & Africa (6 % of net sales). It is a rather large company, which means it is the 13th largest holding in the S&P 500. While many outside of the United States may not have heard of Procter & Gamble, they certainly know some of their brands. Some of their most famous brands are: Pampers (baby diapers), Ariel (laundry products), Bounty (paper towels), Always (feminine care pads), Tampax (feminine care tampons), Gillette (razors and skin care), and Head & Shoulders (hair care). These brands all have high consumer confidence, which is what gives Procter & Gamble a brand moat.
Their CEO is Jon R. Moeller. He first joined Procter & Gamble in 1988 and became the CEO in 2021. Prior to becoming the CEO, he held various position in Procter & Gamble such as Vice President and CFO. He has a Bachelor of Science in biology and a Master of Business Administration from Cornell University. Since Jon R. Moeller has only been CEO for a year, it is hard to determine if he is a good CEO or not. However, the reason he was chosen to be CEO was because he has been credited for being a large part of developing strategies that have resulted in growth and value creation of Procter & Gamble. In an interview with Goldman Sachs, he mentioned that his goal is not necessarily to take market shares from competitors but instead grow the business by growing the market by offering new innovative products to the consumers. He explains it in this quote: "When you can create new opportunities and create new sources of the delight for consumers and clients, good things happen. When all you are doing is trying to punch your competitor in the nose, not so good things happen". I think it is a quite refreshing view to have at competition and how to grow the company. Jon R. Moeller hasn't been CEO long enough to be judged, but he does have a vast experience in the company and a refreshing view at things. Hence, I wouldn't be opposed to invest in Procter & Gamble despite of the unknowns.
I believe that Procter & Gamble has a brand moat. However, there are some uncertainties regarding the management. Now let us investigate the numbers to see, if Procter & Gamble lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years. Procter & Gamble has delivered some solid numbers over the years. There are a few years that have been underwhelming but also some very good years in between, especially the last two years. Overall, I would say that Procter & Gamble has delivered an acceptable ROIC, and if they can continue to deliver numbers like these, I would be a happy investor, if I was invested in Procter & Gamble.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. It is curious to see that Procter & Gamble peeked in 2014 and since then, equity has dropped year over year. There are some reasons for that. They have sold brands to other companies, such examples are 43 beauty brands to Coty in 2015 and Duracell to Berkshire Hathaway in 2016. Furthermore, like many other companies, Procter & Gamble has used cheap debt to buy back shares, which also affects the equity.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditure. Free cash flow has been rater solid over the years, both when you look at the numbers and the yield. 2022 has been an underwhelming year, which I will get into, when we are looking at risks later in the analysis. It would be nice, if Procter & Gamble could get back to around the 5 % yield, as the current numbers are a bit underwhelming.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculation on Procter & Gamble, I can see that Procter & Gamble has 1,58 years earnings in debt. It is well in range, meaning that debt isn't an issue, if you are considering investing in Procter & Gamble.
Based on my findings so far, I believe that Procter & Gamble is a good company. However, no investments are without risk and Procter & Gamble has some risks as well. One risk is higher prices on raw materials and freight. Procter & Gamble must deal with higher prices for raw materials and freight, and in their earnings call in fiscal Q1 2023, management mentioned that higher prices on raw materials and freight resulted in a 550 basis point hit on gross profit margins. Hence, if these prices continued to stay elevated it will affect the profitability of Procter & Gamble. Management mentioned in the same earnings call that raw material prices have remained high, and while freight prices have eased a bit, they are still higher than usual. A strong U.S. dollar. Procter & Gamble generate 51 % of their sales outside of North America, while they report in dollars. It means that a strong dollar will impact their results. In the earnings call in fiscal Q1 2023, management mentioned that based on the current exchange rates, the strong dollar will have a $1,3 billion after-tax impact on their results in fiscal 2023. Competition. In their annual report, Procter & Gamble mentions that they operate in a very competitive market. It is towards other branded products but also private label products. If we see a recession, some consumers might go for the cheaper private labels than the more expensive branded labels. Furthermore, in the earnings call in fiscal Q1 2023, management mentioned that local competitors and non-US dollar denominated don't see the same headwinds in terms of foreign exchange regarding the strong dollar.
There are also positives if you decide to invest in Procter & Gamble. China is moving away from its zero tolerance COVID policy. Sales in greater China decreased in the first quarter in fiscal 2023, and management mentioned that it is because the market is affected by COVID lockdowns and weak consumer confidence that follows the lockdowns. Since then, we have had the news that China is slowly easing their zero tolerance COVID policy, which means that the great China market should soon get back to growth. Management also seems confident in the greater China market, as they mentioned in the earnings call that they expect China to return to strong underlaying growth rates. Better productivity. In his letter to shareholders, CEO Jon R. Moeller mentioned how better productivity will result in top- and bottom-line growth and margin expansion because of cost reduction. He mentioned that no area of costs is left untouched, and they plan to leverage digital tools and automation. Furthermore, he mentioned that they will continue to integrate data, analytics, and artificial intelligence to make their market investments more efficient and effective. A safe dividend. Procter & Gamble has paid a dividend for 132 consecutive years and have increased their dividend for 66 consecutive years. It means that only seven companies in the U.S. have paid a dividend for longer time and only three companies have increased their dividends for more consecutive years.
All right, we have gone through the numbers, potential and risk regarding Procter & Gamble, and now it is time for us to calculate a price for Procter & Gamble. To calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 5,70 which is the one from fiscal 2022. I chose an Estimated future EPS growth rate of 4 (management expects it to grow between 3-5 %), Estimated future PE 8 (which the double of the growth rate, as the historically PE for Procter & Gamble has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $16,68, and we want to have a margin of safety on 50 % so we will divide it by 2, meaning that we want to buy General Mills at price of $8,34 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 16.150. The Capital Expenditures was 2.955. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 2.068,5 in our further calculations. The Tax Provision was 3.327. We have 2.369,697 outstanding shares. Hence, the calculation will be like this: (16.150 - 2.068,5 + 3.327) / 2.369,697 x 10 = $73,46 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 5,65 and a growth rate of 4 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $54,14.
I believe that Procter & Gamble is an interesting company that will be able to perform in any economic environment, as they sell essentials to people. Procter & Gamble has a very strong brand moat and continues to win market shares as 9 out of 10 of their categories won market shares in fiscal 2022. However, they are facing some short-term headwinds with higher prices on raw materials and freight and a stronger dollar. It has hurt margins in fiscal 2022, which resulted in the lowest free cash flow yield than we have seen in 10 years. Nonetheless, these challenges are short-term and should eventually disappear. In the meantime, investors in Procter & Gamble can collect in what seems to be a safe dividend. Personally, I would like to see a higher free cash flow yield before I would invest in Procter & Gamble, meaning that I will not invest in Procter & Gamble for the time being, despite it being a great company.
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