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Bill Ackman's hedge fund, Pershing Square, recently disclosed that it owns roughly 1% of Procter & Gamble's (NYSE: PG) outstanding shares. There are many reasons to be bullish on Procter & Gamble; the company owns some of the best-recognized brands in the world, it's rapidly expanding internationally, management is implementing a $10 billion cost-cutting plan, and the company has a long history of returning value to shareholders.

Owns Best Brands in the World

Procter & Gamble is the bluest of blue chips. It owns 25 billion-dollar brands, including Crest, Charmin, Gillette, Oral-B, and Pampers. As a result of the strong brand awareness and customer loyalty to the brands, all major retailers in the U.S. carry Procter & Gamble products. Because consumers are loyal to the products and retailers have to carry them, P&G has a fair amount of pricing power.

<img src="/media/images/user_13490/pg-pretax-margin_large.png" />

PG routinely earns pre-tax margins just below 20%. Only Colgate-Palmolive (NYSE: CL) boasts similar margins. Competing heavyweights Unilever (NYSE: UL) and Kimberly-Clark (NYSE: KMB) have posted much lower pre-tax margins over the past decade. As long as P&G's brands continue to resonate with consumers, the company will continue posting above-average pre-tax margins.

Expanding Internationally

A large part of the bear case for Procter & Gamble is that the company has overextended itself in emerging markets. P&G was slower to enter emerging markets than Colgate and Unilever and, in an attempt to play catch-up, the firm overextended itself by entering too many new geographic areas too quickly. It has since decided to pull back and retrench in only the largest emerging markets.

Despite the initial disappointment, emerging markets will remain the company's growth component for the foreseeable future. A burgeoning middle-class in developing countries will act as a tailwind for the company as it tries to adapt its model to foreign countries. Already entrenched in American households, we have yet to see whether P&G can establish its brands across borders. If it can, the growth possibilities are endless. If not, then the dividend is about the only return shareholders can expect for some time.

Reducing Costs

In early 2012, management announced huge layoffs as part of an ambitious plan to cut $10 billion in expenses over the next few years. The firm plans to use the additional cash flow to invest in emerging markets and return money to shareholders in the form of dividends and share repurchases. Given that P&G has historically earned close to 30% on invested capital, investors should hope for more reinvestment than return of capital.

Returning Value to Shareholders

P&G has earned nearly $64 billion in free cash flow over the last five years. The company has used most of the cash flow to buy back shares and issue dividends. Expect this practice to continue as the company implements its cost-reduction plan.


At 15x free cash flow, the company is worth about $68 per share. At $70 and change, it seems like P&G is fairly priced absent a major transformation. If you believe that P&G can effectively implement its $10 billion cost-reduction plan and improve its international operations, then you should jump on board with Ackman because the company is going to be producing 50% more free cash flow in the years ahead. But I think it's best to wait and see if management can really pull it off before investing.

titans8904 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Kimberly-Clark, The Procter & Gamble Company, and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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