Important disclosures appear on the last page of this report. September 19, 2011 Consumer Goods (Personal Products) Henry Fund Research Procter & Gamble (P&G) Investment Recommendation HOLD Spencer Anderson spencer-anderson @uiowa.edu Current Price $64.33 Target Price Range $76-79 Source 1 : http://finance.yahoo.com Key Stock Statistics 1 52-Week Price Range $57.56-67.72 Market Capitalization (B) $176.76 Shares Outstanding (M) 2,750 Institutional Ownership 58.1% 60-Month Beta 0.48 Dividend Yield 3.30% Price/Earnings (ttm) 16.37 Price/Book 2.61 Price/Sales 2.09 ROA (ttm) 7.42% ROE(ttm) 18.23% Projected 5-Year Growth 9.40% EPS ($) Year 2009 2010 2011 2012E 2013E 2014E EPS 4.49 4.32 4.17 4.30 4.45 4.67 All earnings represent earnings from operations and have been filtered from net nonrecurring gains. Valuation Models Discounted Cash Flow $90.15 Economic Profit $90.15 Relative P/E $56-61 Dividend Discount Model $62.67 INVESTMENT THESIS (+) Procter & Gamble (P&G) is one of the most stable companies in the consumer staple sector with 50 individual brands that generate $1B in revenue/year. P&G uses the cash flows from these established brands to reinvest in a strong R&D department which continues to innovate and create new products and market segments. (+) Returned capital to shareholders continues to be strong with P&G a 3.3% dividend, which has increased every year for the past 55 years, and a strong $7.0B stock repurchase program with $6.0B expected to be repurchased in 2012. (-) P&G attempted to maintain prices during the recession which led to many consumers trading down to off-brands or private label staple products. The strong US middle class, which P&G targets, has seemed to disappear with much uncertainty as to when or if the middle class will return in the next 3-5 years. (-) P&G’s new pricing strategy does not fit with their business model. Moving down to assist the low-end consumer will deteriorate margins and likely does not allow P&G to increase prices once the US middle class recovers. We see relatively constant margins as higher margin levels in developing economies offset lower US margins. (-) P&G is highly levered to the success of Walmart. Walmart represents 16% of all revenues which allows disproportionate bargaining power against P&G during a time when Walmart is investing in private label branding. (+) International growth remains a catalyst for P&G. By establishing strong relationships with BRIC consumers, P&G will be in a strong position as the middle class grows. P&G intends to increase its average product offering/country from 19 to 24 by 2014 which will lead to higher revenues per consumer.
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Important disclosures appear on the last page of this report.
September 19, 2011 Consumer Goods (Personal Products)
Henry Fund Research
Procter & Gamble (P&G) Investment Recommendation HOLD
Spencer Anderson spencer-anderson @uiowa.edu
Current Price $64.33
Target Price Range $76-79
Source
1: http://finance.yahoo.com
Key Stock Statistics1
52-Week Price Range $57.56-67.72
Market Capitalization (B) $176.76
Shares Outstanding (M) 2,750
Institutional Ownership 58.1%
60-Month Beta 0.48
Dividend Yield 3.30%
Price/Earnings (ttm) 16.37
Price/Book 2.61
Price/Sales 2.09
ROA (ttm) 7.42%
ROE(ttm) 18.23%
Projected 5-Year Growth 9.40%
EPS ($)
Year 2009 2010 2011 2012E 2013E 2014E
EPS 4.49 4.32 4.17 4.30 4.45 4.67
All earnings represent earnings from operations and have been filtered from net nonrecurring gains.
Valuation Models
Discounted Cash Flow $90.15
Economic Profit $90.15
Relative P/E $56-61
Dividend Discount Model $62.67
INVESTMENT THESIS
(+) Procter & Gamble (P&G) is one of the most stable companies in the consumer staple sector with 50 individual brands that generate $1B in revenue/year. P&G uses the cash flows from these established brands to reinvest in a strong R&D department which continues to innovate and create new products and market segments.
(+) Returned capital to shareholders continues to be strong with P&G a 3.3% dividend, which has increased every year for the past 55 years, and a strong $7.0B stock repurchase program with $6.0B expected to be repurchased in 2012.
(-) P&G attempted to maintain prices during the recession which led to many consumers trading down to off-brands or private label staple products. The strong US middle class, which P&G targets, has seemed to disappear with much uncertainty as to when or if the middle class will return in the next 3-5 years.
(-) P&G’s new pricing strategy does not fit with their business model. Moving down to assist the low-end consumer will deteriorate margins and likely does not allow P&G to increase prices once the US middle class recovers. We see relatively constant margins as higher margin levels in developing economies offset lower US margins.
(-) P&G is highly levered to the success of Walmart. Walmart represents 16% of all revenues which allows disproportionate bargaining power against P&G during a time when Walmart is investing in private label branding.
(+) International growth remains a catalyst for P&G. By establishing strong relationships with BRIC consumers, P&G will be in a strong position as the middle class grows. P&G intends to increase its average product offering/country from 19 to 24 by 2014 which will lead to higher revenues per consumer.
Procter & Gamble's (P&G) business is focused on providing branded products of superior quality and value. P&G's products are sold in more than 180 countries. In the FY11, ended June 30th, North America accounted for 42% of total sales, Western Europe 21%, Asia 15%, Latin America 9%, and other geographic areas 13%.
Source
3: P&G 10k
P&G's customers include mass merchandisers, grocery stores, membership club stores, drug stores and high-frequency stores. Sales to Wal-Mart Stores, Inc. and its affiliates represented about 16% of total FY10 revenue
2. P&G's top 10 customers accounted for about
32% of total unit volume.
We recommend a HOLD on Procter & Gamble because of its market position in a slowly recovering economic climate, uncertain pricing strategy in the US, strong ties to Walmart, strong strategic growth initiatives internationally, and its reputation in successfully launching new products. P&G’s strong relationships with its consumers result in a market position of 50+ number one brands worldwide. The 50 most successful brands accounted for 90% of its earnings in 2011. In the past 16 years P&G has had 132 products on SymphonyIRI Group’s list of each year’s 25 most successful new products, more than their six largest competitors combined
3.
COMPANY DESCRIPTION
P&G operates manufacturing facilities around the world in order to distribute and sell its wide variety of products to every consumer on earth. “Touching Lives, Improving Life,” is the company motto as P&G tries to touch all lives in the world and improve each life through P&G products
4. By operating manufacturing
around the world P&G reduces the foreign exchange risk involved with selling products worldwide. P&G
served 4.2 billion customers in 2011 and is on track to serve 5 billion by 2015
3.
P&G had revenues of $83.81B in 2011 through its six reportable business segments: Beauty ($20.16B), Grooming ($8.03B), Health Care ($12.03B), Snacks and Pet Care ($3.16B), Fabric Care and Home Care ($24.84B), and Baby Care and Family Care ($15.61B).
Source
3: P&G 10k
P&G has seen strong growth in the Fabric Care and Home Care segment as well as Baby Care and Family Care segments since 2009. We see this continuing and expect Baby Care and Family Care growing between 3-6% and Fabric Care and Home Care growing between 3-5% through 2015. Other segments are expected to grow between 1-3% through 2015.
Source
3: P&G 10k
P&G uses the strong recurring revenues and cash flows from its six businesses and reinvests into R&D product development. This allows P&G to provide consumers with the most cutting edge products or concepts and establishes brand loyalty. According to CEO, Robert McDonald, “Price promotion may win a quarter here and there, but innovation wins decades.” P&G has executed on this strategy by continuing to innovate with new products and market segments like Crest Whitestrips, Liquitabs, and Febreze. P&G invests
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$2B/year (2.4% of sales or 12.6% of operating income) in R&D which is about 60% more than the closest competitor and more than most of its competitors combined. Beauty P&G is the global market leader in the Beauty category. P&G competes in many different product categories which are generally very fragmented including: cosmetics, female blades/razors, skin care, hair care, and prestige fragrances.
Beauty Brands:
Pantene
Head & Shoulders
Rejoice
Venus
Olay
Covergirl
Secret The Beauty segment distributes its products through the distribution channel located below. P&G mainly relies on mass merchandisers and supermarkets to sell its products and prefers not to sell its products through wholesalers or direct sellers. Beauty is expected to grow at a modest 1% in 2012 as the world economy continues to struggle and pick up to 3% in 2013-14.
Source5: Ibisworld.com
Grooming The majority of Grooming revenues come from male blades and razors. P&G leads in market share for this category in nearly all of the geographies it competes in. The global market share is north of 70%. The dominance in this area is a direct result of the $57B acquisition of Gillette in 2005. This deal included not only Gillette’s signature razor line (Mach III, Fusion, Venus, Sensor), but also Duracell batteries, Braun and Oral-B brands in dental care. The grooming segment is expected to grow at 2% in 2012 before picking up to 4% growth in 2015.
Grooming Brands:
Gillette Fusion
Mach3
Proglide
Braun
Old Spice Fabric Care and Home Care This segment is comprised of laundry detergents, additives and fabric enhancers, dish washing liquids and detergents, surface cleaners, air fresheners, and batteries. P&G holds a #1 or #2 market share in fabric care markets it competes in with 30% of the global market. Home Care owns 15% of the market in the categories P&G competes in. Finally, Duracell batteries hold a 25% share of the global batteries market. Fabric Care and Home Care continue to be fast growing units with P&G continuing to monetize new markets like Febreze and Swiffer. We expect this unit to grow between 3-5% through 2015.
Fabric Care and Home Care Brands:
Febreze
Dawn
Tide
Dash
Ace
Duracell
Bounce
Downy
Cascade
Baby Care and Family Care P&G mainly competes in diapers and baby wipes in this segment with approximately 35% of the global market share. Pampers is the company’s largest brand with $9B in annual net sales. The paper products in this segment are mainly confined to North America and include Charmin bath tissue and Bounty paper towels. Baby Care and Family Care are expected to grow at 3-6% through 2015 as emerging economies are introduced into affordable paper products as substitutes to cloth options.
Baby Care and Family Care Brands:
Bounty
Charmin
Pampers
Luvs Healthcare P&G competes in oral care, feminine care, and personal health. Through its brands, P&G holds a #2 market share in oral care with 20% of the global market. Feminine care products have a 30% share of the global market. In personal health P&G dominates the OTC heartburn market behind Prilosec OTC. Healthcare is expected to have modest growth of 1-4% through 2015.
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Healthcare Brands:
Crest
Oral-B
Prilosec OTC
Vicks
Always Snacks and Pet Care The snacks segment of this business is a declining business due to the divestment of the Pringles brand to Diamond Foods in April 2011
6. This marked the final
food brand divestment for P&G after selling Jif peanut butter, Folger’s coffee, and Crisco shortening. P&G is focused on higher margin products with less competition. These divestments make sense within the P&G business model which revolves around products with long shelf lives and similar distribution channels. We believe this business unit will be renamed to Pet Care for 2012. We do not expect P&G to eliminate this segment because the margins on Pet Care are high and have less competition than the snack industry. This segment is expected to decrease by 15% in 2012 as the revenues from Pringles are removed before increasing by 5% in 2013.
Pet Care Brands:
Iams
Eukanuba The Pet Care segment includes the premium Iams and Eukanuba brands. This business is primarily located in North America where P&G has 10% market share.
RECENT DEVELOPMENTS
Fourth Quarter Earnings P&G reported Q4 2011 earnings on August 5, 2011 of $0.84/share compared to $0.71/share in Q4 2010. This exceeded consensus of $0.82/share due to sales growth in Health Care, Home Care and Family Care, and other net income. Input costs were higher than expected as inflation continues to be a risk to P&G’s margins
7. P&G guided $1.00-$1.04 Q1 EPS 2012 on 6-
9% sales growth and $4.17-$4.33 for FY2012 on 5-9% sales growth. We expect P&G will come in on the lower side of this expectation ($4.17) as margins are squeezed due to the weak US consumer and P&G’s new pricing strategy for some of its products. Dividend Increase P&G increased its dividend by 9% to $0.525/qtr. or $2.10/share for the 2012 fiscal year. This marked the 55
th straight year P&G has increased its dividend and
has paid dividends to investors for 121 straight years8.
For fiscal year 2011 P&G returned $12.8B to
shareholders through dividends ($5.8B) and share repurchases ($7.0B). Divestment of Pringles As previously mentioned, the last remaining snack/food brand with P&G was divested in April 2011 to Diamond Foods for $2.35B. The transaction included $1.5B of Diamond Foods stock distributed to P&G shareholders. P&G will no longer compete in the snack segment and instead focus on higher margin businesses with better synergies. The distribution channels for snacks did not make sense for P&G with many smaller purchasers making it hard for P&G to maintain profitability while continuing to have strong market share
4.
Simplifying Businesses Along with the divestment of the last of the remaining snack businesses, P&G is working on an initiative to simplify its businesses through the use of common packaging, formulas, equipment, and operational systems during manufacturing. P&G aims to move from more than 500 manufacturing platforms in 2009 to 150 by 2014. This will allow product to get to market sooner and around $500M in savings. P&G is simplifying these processes by limiting the amount of choices the consumer has through its product offerings. By using customer research and deep shopper insights P&G plans on making the productivity of its more than 50,000 different product offerings by 30% in the next 3 years
3. Simplifying the
product offerings on the shelf will reduce confusion and increase cost savings. This coincides with the two-tiered pricing/branding strategy. Two-Tiered Pricing/Branding Strategy The economic downturn has disrupted P&G’s strategy of dominating the upper tier of branded products in each segment. P&G’s strategy is typically to have the #1 or #2 market share in each product category it competes in. P&G has typically focused on serving the wealthy and strong US middle class with strongly branded household staple products. As shown by the charts below, the middle class has struggled during this downturn with a rising disparity in income inequality, declining middle-class income, and a very negative consumer confidence level for households earning $35,000-$49,999
9.
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Source
9: Wall St Journal
This has resulted in P&G needing to lower prices for the middle class or risk losing sales through lower prices and coupons. The middle class has essentially evaporated and traded down to off-brand or no-brand staple products which has hurt P&G. To combat this, P&G has recently announced launching products aimed at the lower-income households. The consumers on the high end are still purchasing their trusted P&G products which enables P&G to execute an “hour-glass” branding strategy to keep margins on the high end, while keeping volumes and market share on the bottom end.
INDUSTRY TRENDS
We have a neutral fundamental outlook for the household products sub-industry for the next 12 months. Across the U.S. economy, we think that growth in total U.S. consumer spending will be stronger in 2012 than it was in 2011. However, with the U.S. unemployment rate projected to be relatively high in 2011 and gasoline and food costs rising, we expect that consumers will be quite price-sensitive. In many markets, branded companies like P&G will be vying for market share with private label (store brand) products. In our view, this competition, as well as the leverage of large retailers (specifically Walmart for P&G) has often restricted general price increases for household products.
Economic growth and changing lifestyles in developing international markets should provide growth opportunities for this industry. We expect emerging international markets will see rising demand for packaged products that consumers could previously not afford. Companies in the household products areas have relied on product innovation to bolster sales and profit margins. A number of companies continue to control costs effectively and are looking for additional ways to operate more efficiently
5. In the long run, partly
due to the slow growth seen in developed markets, large multinationals will continue to seek growth opportunities in developing and emerging markets. For multinational companies, we expect that the impact of foreign currency translation will depend, in part, on which markets a manufacturer is selling to, and the
extent of currency hedging. The key raw materials that impact the household products sub-industry include natural gas, crude oil, pulp and resin. Year to date through September 19, the Consumer Staples ETF (XLP) was up 4.33%, compared to a 4.25% drop for the S&P 1500 Index. In 2010, the sub-industry index advanced 4.4%, versus a 14.2% rise for the S&P 1500
10.
MARKETS AND COMPETITION
Source
1: Yahoo! Finance
P&G operates in the Cosmetic & Beauty Products Manufacturing, Soap & Cleaning Compound Manufacturing, and Other Converted Paper Product Manufacturing industries which are driven by price and brand awareness. The chart above highlights stock performance of the past year for P&G’s main competitors in these industries including: Colgate-Palmolive, Kimberly-Clark, Church & Dwight, and Energizer Holdings. None of these companies compete with P&G in all of the industries it competes in which makes comparing the companies difficult. Colgate-Palmolive mainly competes in the Soap and Cleaning Compound Manufacturing.
Price to Sales (2011)
Source
1: Yahoo! Finance
Price to sales (P/S) ratio measures how much investors are willing to pay for each dollar of sales. This chart shows the strong marketing companies in the Cosmetic & Beauty Products Manufacturing and Soap & Cleaning
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Compound Manufacturing like Colgate-Palmolive and Church & Dwight are priced at a premium for each dollar of sales compared to Kimberly-Clark who competes strictly in Other Converted Paper Product Manufacturing. P&G is in the middle which makes sense for the different business segments it competes in.
Asset Turnover (2011)
Source: MSN Money
11
Asset turnover measures total sales divided by total assets. It measures how effectively a business is using its assets to generate sales. P&G is at the bottom of its competitors in this metric with a 0.6 value. P&G is the least efficient in asset turnover which is partly explained by the amount of R&D which gets capitalized on its balance sheet.
Operating Margin (2011)
Source
1: Yahoo! Finance
Operating margin is the measure of operating income over total revenues. A higher operating margin indicates a more efficient company allowing it to pay off its fixed costs. The difference in margins across the industry is a direct reflection on the relationships these consumer staple companies have developed with their customers. P&G and Colgate-Palmolive are the leaders in this category. Both companies invest in R&D
to develop new products and create new markets which allow them to establish the first relationship with the customer and also strong market share which allow for high margins on their new products. These new products and the relationship created with the consumer are what drive profitability for both companies. Companies which sell more commoditized products like the paper product offerings from Kimberly-Clark result in a lower margin due to the lack of differentiating factors in product offerings.
Market Share (Cosmetic & Beauty Products Manufacturing in the US)
Source13
: IBISworld.com
It is difficult to measure P&G’s market share against its competitors because it competes in a variety of consumer staple product categories and industries including Cosmetic & Beauty Products Manufacturing, Soap & Cleaning Compound Manufacturing, Other Converted Paper Product Manufacturing, and Pharmaceutical and Medicine Manufacturing. It is safe to say that P&G is by far the largest competitor in each of these industries. P&G uses its size and distribution channels to its advantage by reducing costs from suppliers and using its economies of scale. This is a large advantage when the largest portion of operating costs are from product purchases.
Industry Costs (2010)
Source
5: IBISworld.com
With 58% of costs coming from purchases from suppliers, market share and economies of scale are extremely important for manufacturers in this industry. As the largest manufacturer in the industry P&G takes advantage of its economies of scale to get the best possible price from its suppliers. P&G also focuses on products with long shelf lives in order to buy in bulk and
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store inventory for when it is needed. Management has guided that it intends on streamlining the manufacturing process by using similar inputs for many of its products which will give them greater leverage on suppliers going forward.
The other large portion of costs come from the “other” category and include SG&A. This includes the large marketing budgets of many of these manufacturers as they try to educate consumers about new products and to promote existing products. P&G’s SG&A costs are much higher than the industry average due to the emphasis on marketing and creating a relationship with the consumer.
ECONOMIC OUTLOOK
The recession in the US has been over for more than a year and a half, but there remain strong global economic risks and a fear that we may already be in a “double-dip” recession. High unemployment remains in many developed countries and European default risks also pose strong threats to the global economy.
GDP
Real GDP grew by 1.3% in Q2 2011 growing for the 8th consecutive quarter. We feel real GDP will continue to grow around 1.5% in the next two quarters with a two year forecast of 3.0% average growth/quarter. This sluggish US recovery will continue to affect P&G’s core consumer’s ability to pay for P&G’s premium products.
Source
12: Bureau of Economic Analysis
Unemployment
Unemployment continues to be a concern on the outlook for the US economy. The rate continued to fall in 2010 and stands at 9.1% in September of 2011. This rate can be somewhat misleading because it does not account for all “discouraged workers” who have stopped looking for jobs. The consensus of the Henry Fund is a real unemployment rate around 9.1% for the
next six months dropping to around 8.2% in the next two years. We feel the politicians in Washington will have the political will to pass a bill aimed at creating jobs and infrastructure in the US which will help bring the unemployment rate down. We also feel that if US businesses could gain some political/tax clarity it would lead to accelerated hiring. Many businesses are sitting on their hands waiting for D.C. to finalize financial, healthcare, and tax reforms before making investment/hiring decisions. The high unemployment rate during the recent recession has been a negative for P&G as consumers became more price sensitive and traded down from P&G’s higher end products to private label and off brands. We feel the above average unemployment rate going forward will continue to be negative for P&G as consumers will be more price conscious due to the freshness of the worst recession in recent memory.
Source
13: Bureau of Labor Statistics
Inflation
Inflation has been low throughout the recession and recovery. In 2009 the CPI declined by 0.36% before rising to a moderate 1.64% in 2010. The Henry Fund fears a sharp spike in inflation as energy, grains, and metal prices have increased significantly in 2010 and the beginning of 2011. We expect inflation to rise to 2.3% in the short-term and increasing to 2.8% over the next two years. P&G continues to try to hedge this risk through derivative contracts, but increased input prices continue to be a concern for P&G. P&G uses interest rate swaps, forward currency swaps, and futures/options/swaps on commodities like oil, plastic resin, and other inputs. P&G has tried to maintain margins/prices during this downturn and has realized many consumers are trading down to private label or cheaper brands. We feel P&G will continue to struggle in passing on prices to US consumers if energy and input prices continue to spike.
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Source
13: Bureau of Labor Statistics
Consumer Sentiment
Consumer sentiment has plummeted over the summer and is testing its low in November 2008. The latest report of 57.8 for mid-September is a dramatic decrease from the 74.5 May report and slightly above the consensus of 56.0. This decrease in sentiment is due to the continued high unemployment, continued high energy prices, S&P’s downgrade of the US debt, and economic uncertainty in Europe. We feel consumer sentiment will improve to stay within the 65-70 range over the next two years. This increase in consumer sentiment should benefit P&G as consumers become less price sensitive.
Source14
: Bloomberg Economic Calendar
Currency Risk
With products in more than 180 countries, P&G faces significant currency translation risks. P&G attempts to hedge these translation risks using derivatives. It especially manages risk in countries with currency exchange controls like Venezuela, China, and India. We feel the dollar will strengthen against the Euro and Yen in the next two years which will be a negative for P&G as a stronger dollar will result in lower revenues
and earnings for the 63% of revenues that occur outside of the US.
Median Household Income
The median household income continues to remain stagnant as the US economy struggles to grow. With median income at near 1998 levels, the disparity in income continues to be a negative for P&G. This recession has seen the middle class evaporate and with it P&G’s pricing power for its products which are mainly aimed at middle class America. We see continued stagnation in household incomes.
Source
9: Wall Street Journal
CATALYSTS FOR GROWTH
International growth
International growth will be the #1 catalyst for P&G going forward. The US market delivers 37% of the $82.6B in annual sales and an estimated 60% of the $11.8B in profit. P&G estimates US consumers spend $96/year per person compared with $4/year per person in China and $1/year per person in India and Sub-Saharan Africa. As US consumers continue to struggle P&G will have to look to growing economies like the BRICs where the middle classes are starting to demand quality consumer staple products. P&G is already entrenched throughout the world (180 countries), but is phasing in many of its branding/pricing strategies as the discretionary income for the middle class grows. For example, in India P&G introduced a low-cost Mach3 razor which gained 15% market share within the year
3.
As salespeople and marketing continue to educate consumers about P&G’s superior razor products, it decided to launch a more premium product, the Gillette Guard. This strategy allows P&G to test the market’s price sensitivity before launching more risky high-margin products. We see P&G continuing to use this strategy in a wide variety of their product segments in the BRIC countries. BRIC margins will be lower than developed economies as P&G captures market share.
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Expanding Product Categories
P&G competes in 38 product categories and, on average, compete in 19 categories in any given country. The US is the most developed market with 35 product categories. In China, Brazil, and India P&G competes in 18-19 categories. Mexico and Russia are in the 20’s. P&G has a goal of raising the average amount of categories in any given country from 19 to 24 by 2016
3.
Joint Venture with Teva Pharmaceuticals
P&G exited the pharmaceuticals business 2 years ago to focus on consumer-oriented healthcare. The joint venture is in negotiations and would give P&G access to: Teva’s manufacturing scale as the largest prescription drug manufacturer in the world, their library of molecules, their regulatory capabilities, and pharmacy coverage in many markets. This would allow both companies to accelerate entry into additional OTC categories and markets. The venture is scheduled to be finalized by the end of 2011
3. P&G realizes their
expertise is in marketing and that they can leverage their distribution channels to be a player to provide OTC medications.
INVESTMENT POSITIVES
P&G is the most well known consumer staple company in the world with strong brands and superior products. Continued innovation leads to new market segments and strong market share in nearly every category P&G competes in.
With 24 brands producing more than $1B in annual sales and 50 leadership brands P&G has strong recurring sales and brand loyalty with much of its customer base.
Growth in the BRIC countries is expected to be strong in the coming 7-10 years as economic growth leads to higher discretionary income for more than 3 billion consumers. 270 million consumers are expected to be added to China’s middle class by 2020. P&G expects to serve 5 billion consumers by 2015.
P&G provides a healthy dividend and share repurchase program to its shareholders. If growth prospects do not end up as rosy as we expect the 3.3% dividend yield and the $7.0B in share buybacks to continue to bring a strong return compared to its peers. We expect P&G to increase their dividend payout ratio to above 53% in 2015 from 47% in 2011.
INVESTMENT NEGATIVES
Walmart accounts for 16% of P&G’s revenues. This threatens margins and pricing power. Walmart can exert an extreme amount of pressure on P&G to continue to make P&G the preferred supplier for consumer staple products. If the US consumer continues to struggle it will be hard for P&G to continue demanding the preferred aisle and shelf placement or Walmart could decide to compete with its own private label products.
With Walmart and P&G in our portfolio we are placing a large bet that these two companies will continue to be “in bed” with one another in the near term. This is an unnecessary risk, especially when we feel uncomfortable with the weakness of the US consumer going forward.
The “hour-glass” pricing strategy is a risky and unproven. Management is executing this strategy after a failed attempt to maintain pricing/branding during the recession. This will cut into margins at a time where management has stated they want to divest “non-core” products/brands which do not have strong margins.
P&G is such a behemoth of a company that it will be difficult for it to “move the needle” with any one new product innovation or establishment of a new market.
Continued weakness in developed economies will test P&G’s margins as the middle class tries to stay afloat. Europe will see continue weakness through 2013.
VALUATION
Our HOLD rating is based on an expected price of $76-$79. This range is given based on the prices for the three valuation techniques used. More weight was given to the DCF/EP model and DDM model when calculating this range because the relative P/E model does not reflect that P&G trades at a higher multiple because of its higher margins. The DCF/EP model produced a price of $90.15 while the DDM produced a price of $62.67 and the relative P/E produced a range of $56.22-$60.28 for 2011 and 2012 estimates.
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Revenue growth was modeled as follows in the 6 business segments:
P&G is one of the largest product manufacturers in the world and is not expected to grow faster than a few percentage points based on its sheer size. P&G’s stated goal is 2-3% growth over Household Product industry growth. The growth forecasts were calculated based on management’s stated growth in each segment as well as past performance. The 10% decline in revenues for Snacks and Pet Care is a result of the Pringles divestiture. We envision muted 2012 growth as the developed economies continue was struggle before an uptick in 2013 followed by reasonable growth in 2014-15 to CV. We expect a slight decrease in margins through 2014 as P&G sells more to emerging markets and struggles to pass on costs to US customers. P&G faces a large variety of competitors in a variety of industries including discount retailers, membership warehouses, grocers, and internet retailers. The relative valuation model includes companies from all of these different industries. One thing to note is the inclusion in the first P/E calculation and then subsequent removal of AMZN in a second calculation due to it being an outlier relative to the other companies. Our models assume a risk free rate of 3.25% (30 Yr Treasury rate as of 9/18/2011) a market risk premium of 4.50%, a beta (3 yr monthly) of 0.48, cost of equity (CAPM) of 5.41%, a cost of preferred shares of 15.2%, and an after tax cost of debt of 3.33%. The WACC calculated using these inputs was 5.79%. The continuing value used in the model was a conservative 2.00%. We chose conservative estimates for continuing value because P&G is a very mature company. Cost of sales was modeled using the margins of each segment leading to a specific percentage of sales and is a very sensitive number for a firm with as large of sales as P&G. Cost of Sales along with SG&A expenses were modeled in the sensitivity tables. The
DCF/EP price is fairly sensitive to these costs with a 10% move in the stock when COGS and SG&A are moved 1%. SG&A expenses will vary as P&G launches into new product categories in emerging market countries. We have P&G as a HOLD. However, a few events could trigger us to review our decision: International growth increases significantly. International growth will be the key driver for P&G and an inability to enter some of the new markets through adding product lines would lead to increased organic growth and an appreciation in P&G’s future stock value.
A bounce back or catalyst to spark the middle-class American. A decline in unemployment or increase in median incomes will help P&G’s core customer.
Success in the hour-glass pricing strategy. It seems that helping the consumer trade down to lower margin or lesser quality goods does not align with P&G’s business model because of the intense competition at the low end and the difficulties in passing on price increases once incomes increase. If the volumes and margins end up being higher than expected, P&G’s earnings and stock value will be higher than expected.
A divestment of Walmart in the Henry Fund. With two companies so dependent on one another to succeed, it seems counterintuitive to hold two low beta consumer staple stocks that expose the fund to the same risks. If Walmart was divested, P&G would look more attractive as an investment for the fund in this sector.
Henry Fund Research
THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
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REFERENCES
1. Yahoo! Finance: finance.yahoo.com 2. P&G Unhappy With Walmart Venture’s Execution. Reuters.com. 3. P&G Annual Report 2011. 4. P&G Corporate About Us: http://walmartstores.com/AboutUs/295.aspx 5. IBIS World Industry Overview: www.ibisworld.com 6. Once A Great Flop, Now Sold for Billions. April 5, 2011. The New York Times. http://www.nytimes.com/2011/04/06/business/06pringles.html 7. Net Advantage. Standard & Poor’s Corporate News. http://www.netadvantage.standardandpoors.com/NASApp/NetAdvantage/cp/showDailyNews.do. 8. Procter & Gamble Announces Another Dividend Increase. April 12, 2011. eDividend Stocks.com. http://www.edividendstocks.com/2011/04/procter-gamble-announces-another-dividend-increase/ 9. As Middle Class Shrinks, P&G Aims High and Low. The Wall Street Journal. September 12, 2011. http://online.wsj.com/article/SB10001424053111904836104576558861943984924.html 10. Net Advantage. Standard & Poor’s Industry Review. September 19
th, 2011.
http://www.netadvantage.standardandpoors.com/NASApp/NetAdvantage/cp/companyIndustryPage.do 11. MSN Money: www.msnmoney.com 12. Bureau of Economic Analysis: www.bea.gov 13. Bureau of Labor Statistics: www.bls.gov 14. Bloomberg Economic Calendar: http://www.bloomberg.com/markets/economic-calendar/
IMPORTANT DISCLAIMER
This report was created by a student(s) enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa’s Tippie School of Management. The intent of these reports is to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.