Why This Takeover Target Will Outperform Stabler Peers

By David Gould - October 3, 2012 | Tickers: CL, PG, CLX | 0 Comments

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Consumer goods are a shaky sector to back right now. The macro story is still largely uncertain and consumer confidence is at an abnormally low level. Even still, the risk may be worth the upside should the economy fare better than expected. Under such a backdrop, it is better, in my view, to back the riskier consumer good stocks if the sector is to be backed at all. Below, I review three companies to support my argument.

Procter & Gamble, Colgate: Boring = Low Returns

P&G (NYSE: PG) may the most sustainable consumer goods business in the world, it still is overly expensive at a respective 22.3x and 16.4x past and forward earnings. The dividend yield currently stands at 3.2% largely because growth prospects are so limited. Moreover, the business is worth more in sum than it is in parts, as indicated by the price-to-book ratio of 3x.

Perhaps most disappointingly, analyst ratings have fallen in recent days. RBC Markets downgraded P&G from "outperform" to merely "sector perform" and from a price target of $70 to $64, which is about 8% below the current valuation. Caris & Co. is even more negative and gives the company a $62 price target.

In my view, I see no more than the 8.5% annual EPS growth forecasted over the next 5 years. Given that this is more than quadruple what was achieved in the preceding 5 years, I believe it is also optimistic. Assuming that the forecast is met, 2016 EPS would come out to $4.91, which, at a multiple of 16x, translates to a future stock value of $78.56. Discounting backwards by 7% yields a present value of $56. Accordingly, I find that the stock is overvalued and not worth its safety.

Colgate (NYSE: CL) has been on a rally for the year to date with the stock up 27.3% from the 52-week low. Even still, I find shares are overly pricy at 18.3x forward earnings and a dividend yield of 2.3%. This multiple is largely a result of the 15% annual EPS growth over the past 5 years, which dwarfed what was achieved by peer P&G. Even still, analysts are not really any more optimistic about Clorox's future prospects and, accordingly, rate it a 2.7 out of 5 where "5" is a "sell". On the positive, however, analysts have gotten more optimistic with Argus upgrading the stock from "hold" to "buy" at a new price target of $118.

Clorox Worth The Risk

For me, it is now an attractive time to back riskier stocks like Clorox (NYSE: CLX). The company trades relatively cheaply at a respective 17.5x and 15.6x past and forward earnings with a dividend yield of 3.6%. The company has been weak over the last 5 years and only grew earnings by 5% annually. Investors and analysts have since lost much faith in the fundamentals, and the Street now rates it closer to a "sell" than a "buy".

Given how beaten up the stock is, it should not be surprising that Carl Icahn earlier this year attempted to get management to sell the business. Equipped with a strong portfolio of brand name products (eg. Disinfecting Wipes to Clean-Up Bleach), Clorox should see many suitors that have a larger geographical exposure to unlock meaningful revenue and cost synergies from an integration. I believe this has not been accurately reflected into the stock price given that the company has underperformed over the 52 weeks since Icahn started emphasizing the potential value. When the economy starts picking up, I believe the low bar set by analysts will be exceeded to help elevate multiples more towards peer levels.

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