Procter & Gamble– Earnings Preview in Light of Ackman’s Statements

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The fiscal second quarter results of Procter & Gamble (NYSE: PG) should be out before the markets open on Friday, January 25, 2013. Analysts forecast an EPS of $1.11 for the quarter. While whether or not the Cincinnati-based company will surprise analysts as it has been doing for the past four quarters is of short-term interest, the world’s largest consumer products manufacturer deserves a look for its long-term prospects.

The fact of the matter is that there is far too much attention paid to short term analysis by investors. There is a vast majority of investors out there who are not worried about valuations and at what price they buy a stock. All they are looking for is to get some sort of an advantage from earnings forecasts. In this rush for quick profits, little attention is paid to fundamentals and stock price in relation to valuation.

The company

Although incorporated in 1905, Procter & Gamble started business in 1837 and has grown from a soap and candle supplier to a global behemoth manufacturing packaged consumer goods that sell in 180 countries.

The company operates in five segments organized in two Global Business Units and owns some of the most well known brands across segments:

  • Beauty: Olay, Hugo Boss and Dolce & Gabbana (fragrances) and Head and Shoulders
  • Grooming: Braun, Fusion, Gillette and Mach3
  • Health Care: Oral-B, Vicks
  • Fabric Care and Home Care: Ariel, Duracell and Tide
  • Baby Care and Family Care: Charmin, and Pampers

Procter & Gamble holds nearly 25% of the global market for batteries, 30% share of the market for male shaving products and above 40% of female epilators market.

Financials

At current market price of $70.69, the market cap of PG is $193.28 billion. It also sports an enterprise value of $219.21. With an EPS of $3.06, the stock is trading at P/E ratio of 23.06. It has been paying quarterly dividends regularly and the last dividend payout at the rate of 0.81% or 56.2 cents was on Jan. 16.

For the quarter ended September 29, 2012, the company reported total revenue of $20.74 billion, which is roughly 2.61% more than the previous quarter ended June 29, 2012. However, during the same period, net income dropped by 22.5%.

On a yearly basis, PG’s total revenue for the year ended June 29, 2012 was $83.68 billion, up by 3.1.8% from $81.10 billion reported for the prior year whereas cost of revenue increased 6.35%. Net income in fiscal 2012 was lower by 8.82% as compared to fiscal 2011.

Net sales of the company by market maturity were 62% in the developed markets and 38% in the developing world.

The most recent quarter figures place the book value of each share at $23.09 and at CMP of $70.69 (close of trading, January 23, 2013), its price to book ratio is 3.06.

Issues

  • The increase in cost is a major issue and the company plans to address it by cutting $10 billion in costs by 2016, partly through reduction in workforce.
  • While its biggest rival, Unilever N.V. (NYSE: UN) is boosting its sales in emerging markets, despite its competitive advantage, P&G has not been able to perform as well as it should have in the emerging markets, which account for almost 40% of its net sales.
  • Inconsistent pricing with P&G frequently increasing and lowering prices of its products opened the doors for competitors in the domestic as well as global markets.
  • Gillette, the company that P&G acquired in 2005, is known for improving its existing products and raising their prices. While Gillette complemented the company’s image as an owner of leading brands, the global recession just a few years after the merger resulted in consumers shifting to other lesser known brands.

In the past five years, P&G has underperformed as compared to its major global competitors – Unilever as well as Colgate-Palmolive Company (NYSE: CL).

The fourth quarter and full year results of Unilever showed strong growth in 2012. While turnover increased by 10.5%, sales grew by 6.9% along with a volume growth of 3.4%. Unilever's sales were boosted by robust sales in emerging markets, which now account for 55% of total sales, a jump of 11.4%, a clear signal that a lot can be achieved with the right focus.

Colgate-Palmolive is a slightly different consumer products company as it is more focused on oral, personal and home care and pet nutrition. Colgate-Palmolive’s fourth quarter 2012 and year end earnings conference call is on January 31. During 2012, the EPS of the company increased from $1.24 in first quarter to $1.38 per share in third quarter. Analysts expect a 2-cent increase in EPS in the fourth quarter. However analysts expect earnings to grow 9.88% in 2013 and 9.4% over the next five years.

Ackman’s broadside

Activist investor and hedge fund manager Bill Ackman, who having directly or indirectly invested $2 billion, owns 1% of P&G. He has been making statements such as lack of confidence of senior management in the current CEO, lack of innovation and the company being too “bloated” and a need for unlocking hidden value.

Anyone owning 1% of a publicly traded company has the right to make such comments. However, even though the company responded by saying that, "The situation is unchanged" Ackman’s comment did stir up the price of P&G stock.

Conclusion

The problem with P&G is that it is an extremely large company – actually almost 40 businesses in one single unit. It is no wonder then that Ackman is hankering for unlocking hidden value, which I believe can be achieved by splitting-off segments and putting them under separate managements. Moreover, by doing so, the company can get better return on the investment of $2 billion that it makes on R&D.

All this requires a planned approach to boosting sales and not by direction-less cost cutting primarily focused on reducing cost of sales. Cost cutting after years of underperformance smells of inefficient management.

That the stock is trading at 3.06 times book-value and almost at its 52-week high would be a worrying point for value investors. However, what needs to be considered is that PG has brand portfolio valued at more than $25 billion. This is reason enough for it to trade at a premium. However, this is relevant only when there is confidence in management’s vision of the future, which is the bigger worrying factor.

There is also a possibility that Ackman stirs up enough dust for the company to wake up and take some planned actions going forward. With institutional ownership at 58% of the total float, it may be difficult to ignore an investor who owns 1% of the company.

Having said that I must come back to where I started from – fundamentals. Whatever we are hearing in the news has more relevance for the short term investor. For value investing, we need to look at the fundamentals.

PG has an operating margin of almost 20% and a 14.05% return on equity. Consensus analyst earnings growth forecast is 3.10% for 2013 and 8.86% for 2014. After cost restructuring and with the global economy showing signs of recovering, PG’s EPS could easily grow more than analysts forecast.

Despite recent poor performance, the future outlook for P&G remains positive. In the last ten years, the company has returned 90% of its net earnings to shareholders. As a value investor, I would wait for the stock to come down to realistic levels before buying.

Note: All financial data sourced from www.finance.yahoo.com unless mentioned otherwise.


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