Good Time to Buy Procter & Gamble

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Jul 06, 2014

Procter & Gamble (PG, Financial) has certainly missed the rally over the last one year with the stock remaining stagnant over this period. However, the company remains a great investment for the long-term and investors can consider the stock price stagnancy as a good buying opportunity. This article discusses the reasons for remaining bullish on Procter & Gamble.

The first factor has to do more with the company’s fundamental strength and the current US market valuations. In all probability, the US market will witness some correction over the next 6-12 months as the Fed tightens its monetary stance. Further, the market has been surging and a correction is imminent relatively soon. Procter & Gamble is a perfect defensive stock to own with a low beta of 0.4. A very stable dividend and a current dividend yield of 3.2% is an added positive.

Procter & Gamble’s organic sales growth has averaged just 3% on a quarterly basis in the last two quarters. This might suggest to some investors that the market in which Procter & Gamble is operating is saturated. However, all key segments the company is focused on, has relatively strong growth prospects over the next 5 years.

The baby care segment is expected to grow at 4.2% over the next five year, the beauty segment at 4.7%, the fabric & home care segment at 3.8% and the health & grooming segment is expected to grow at 4.4% over the next five year. Overall, the company’s core segments will grow at an average of 4.4% annually.

Amidst this growth, the biggest positive for Procter & Gamble is the contribution from developing markets. Procter & Gamble’s net sales from emerging markets are at $33 billion as compared to $24 billion for Unilever (UL, Financial) and $10 billion for Colgate (CL, Financial). Therefore, the company is best positioned to benefit from emerging market growth. The investment horizon should be relatively long-term as the benefits of emerging market exposure will be evident gradually and increasingly.

After recording three successive quarters of core EPS de-growth, Procter & Gamble’s core EPS has increased by 5% in the first quarter of calendar year 2014. The company’s stock will join the broad market rally if the growth in core EPS continues. Procter & Gamble has guided for core EPS growth of 3%-5% for 2014 and a currency neutral core EPS growth of 12%-14%. Currently, the company faces the largest foreign exchange headwind ever and as the company finds a way through this challenge, the EPS will get a boost. Therefore, sentiments are likely to get bullish for the stock in the foreseeable future and the currency might not always dampen the company’s profits as it has done in the recent past.

The company’s cost saving measures will also add to EPS growth in the future. In 2012 and 2013, the company’s COGS savings were to the tune of $2.5 billion. For 2014, the company expects cost savings to be much higher at 1.6 billion. I expect marginal EBITDA margin expansion as a result of this cost saving and this should additionally boost the EPS.

Another positive from a long-term holding perspective is the value returned to shareholders on an annual basis. Over the last ten years, Procter & Gamble has returned $9.8 billion to shareholders on an average through dividends and share repurchase. Further, the company intends to return $11.5 billion to $13.5 billion to shareholders in FY14 and this translates into a shareholders yield of 5.5% to 6.5% (as a percentage of market capitalization). Therefore, the expected returns are high and attractive for this defensive stock.

As a result of depressed stock sentiment over the last one year, Procter & Gamble is currently trading at a PE of 21.3. This is certainly attractive as compared to Colgate, which is currently trading at a PE of 29.6 while Unilever trades at a PE of 20.2. However, a relatively PE premium for Procter & Gamble is justified over Unilever as the former has greater exposure to emerging markets as discussed above.

In conclusion, the currency exchange headwinds have impacted core profits for Procter & Gamble in the last few quarters and have also depressed the stock. However, the company’s fundamentals remain excellent from a value creation perspective. Also, higher exposure to emerging markets will ensure that the company grows at a relatively strong pace. I expect some positive surprises and stock upside when the company announces its fourth quarter earnings in August.