Puzzling Over PG (Procter & Gamble)

Procter & Gamble (PG) is the world’s largest manufacturer of consumer products with an impressive line-up of famous brands, 23 of which had sales of over $1 billion each in 2010.

PG was the Online Stock Study at the Better Investing website for June 2011 and was led by Ken Kavula and Eve Lewis.  Ken is the Chairman of the Better Investing Volunteer Advisory Board and Eve is a Trustee of the NAIC Board of Directors.

The webinar recording is available to BI members as are the presentation slides and other handout materials.  Sadly, and once again, no SSG has been made available, even though a completed SSG is the stated purpose of the Online Study.

Company Background:

– Procter & Gamble’s 2010 sales were $78.9 B, according to  Morningstar SSG data, down –0.1% from 2009; sales growth has been trending down for the last ten years and was negative for the last two.

– EPS growth has follwed the same trend: down -1.4% last year, trending down for the last ten, and negative for the last two.

– Value Line reported that sales in the U.S. accounted for 38% of total sales and sales to Wal-Mart represented 16% of the total.

– PG is organized into three Global Buisness Units (GBUs): Beauty & Grooming (34% of 2010 sales); Health and Well-Being (18%); and Household Care (48%).

– The 23 Billion Dollar Brands by GBU and segment, according to PG’s 2010 10K Annual Report, are:

 ** Beauty and Grooming:

• Beauty ($19.5B & 24% of 2010 sales): Head & Shoulders, Olay, Pantene, Wella;
• Grooming ($7.6B & 10%): Braun, Fusion, Gillette, Mach3;

** Health and Well-Being:

• Health ($11.5B & 14%): Always, Crest, Oral-B
• Snacks and Pet Care ($3.1B & 4%): Iams, Pringles;

** Household Care:

• Fabric and Home Care ($23.8B & 38%): Ace, Ariel, Dawn, Downy, Duracell, Gain, Tide;
• Baby and Family Care ($14.7B & 18%): Bounty, Charmin, Pampers

– PG sells its products in more than 180 countries with sales in the U.S by far accounting for the largest geographic segment.  North America accounted for 42% of sales; Western Europe, 21%; Asia, 15%; and Latin America, 9%.

SSG Discussion :

– After the following comparative table, I discuss several key SSG issues, PG’s competitors, its Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE), and its Financial Condition as well as some Final Thoughts about PG.   

Procter & Gamble (PG)	Consensus/       Ken SSG	Armin-1	Armin-2 (optimistic)	Take Stock
Date	6/1/11	Same	Same	Same
Data	Mstar via BI	Same	Same	Same
Price	$65.14	$66.40	Same	Same
52 week High & Low Price	N/A	$67.72 & $58.52	Same &            Same	N/A
Last Quarter of  Reported Data	Q3 ending 3/31/11	Same	Same	Same
Software Used	BI Online SSG	TK 6	Same	TS Online
Project Growth   From End of	Last Q	Same	Same	Last FY
Sales Growth	5.00%	8.00%	Same	-2.20%
EPS Growth	7.00%	8.00%	10.00%	-1.30%
High PE	20.0	18.3           (from 2010)	19.4            (ave 09-10)	20.6
High EPS	$5.33	$5.58	$6.12	$3.30
High Price	$106.60	$102.10	$118.78           (8% > VL)	$67.90          (25% < VL)
Value Line Estimated High Price = $90-110 as of 4/1/11
Low PE	12.0	11.2                (from 2010)	11.7 (ave 09-10)	15.4
Low EPS	$3.80	Same	Same	$3.49
Low Price	$45.60                 (Low PE x          Low EPS)	$50.20              (ave Low Price last 5 years)	Same	$66.40              (Yield Supp’ted Low Price)
Upside/Down	2.12	2.2	3.2	Not Used
Total Return	12.58%	11.4%	14.6%	3.10%
SSG Buy Under	N/A	$56.49	$66.27	$38.40
RV/PRV             (no outliers)	N/A	95.2/88.4	Same/86.8	Not Used
RV/PRV	N/A	Not Used	Not Used	Not Used
Quality	N/A	Not Used	Not Used	TS = 1.6 unacceptable
PTPM –             5 yr ave	N/A	19.00%         Trend even	Same              Same	Same            Trend N/A
ROE – 5 yr ave  End Yr Equity	N/A	15.70%           Trend up	Same                 Same	Not Used
ROE – 5 yr ave  Begin Yr Equity	N/A	21.5%            Trend down	Same               Same	Same                  Trend N/A
Debt to Equity –5 yr ave	N/A	40.20%            Trend down	Same               Same	Not Used

Estimating Future Sales Growth for the next 5 years:

– Ken gave the participants 4 choices to estimate Procter & Gamble’s future Sales growth: 10.00%, PG’s 10 year historical growth rate; 3.30%, its last 5 year  growth rate; 13.50%, its pre-recession 5 year trend; and 4.5% to 5.00%, long-term estimates  by Morningstar and Value Line.

** He also offered ‘Something Else’ which is a meaningless choice that I will disregard. 

** VL’s 5.00% estimate was for Sales per Share, not Sales.

** The only long-term Sales estimate I know of is from Zacks.com which was 1.97% for the next 5 years.

** The Consensus [71%] voted for 4.5% to 5.00% and Ken made the final choice at 5.00%, VL’s long-term estimate for Sales per Share.

Estimating Future EPS Growth for the next 5 years:

– Ken offered 4 (meaningful) options to estimate PG’s future EPS growth: 13.70%, its 10 year historical growth rate; 7.70% – 8.00%, its last 5 year rate as well as VL’s long-term EPS estimate; 10.00%, its pre-recession 5 year trend as well as Zacks via BI estimate (what Ken called an Analyst’s Consensus Estimate or ACE), and 6.10%, from Ken’s Preferred Procedure.

** The PP involves 4 estimates for the next 5 years, only one of which Ken changed from the standard, pre-set default values: he increased the Pre-Tax Profit  Margin from 19.0% to 19.4% without explaning any reason(s) for his change.

** Sales growth already had been decided by Ken at 5.00% and he made no change in the default value for Preferred Dividends ($219 M) or the Tax Rate (27.3%) even though VL was estimating an increase to 28.0%.

** Although his PP resulted in 6.10% and the Consensus [45%] voted for 6.10%, Ken chose 7.00% EPS which he did not explain and which was not offered as one of the choices.

– The seven different long-term EPS estimates I ALWAYS check for every SSG I do averaged 9.20% with CNNMoney and Zacks via BI high at 10.00% and VL low at 8.00%.

** I chose 8.00%, VL’s estimate and the lowest of the seven I checked.  

** To learn how I estimate future EPS and the names of the seven estimates I ALWAYS check, see: Estimating EPS [click here].

Forcasting the High PE:

– Unlike the prior two decisions, Ken offered no choices to the participants and decided to use 20.00 as his Forecast High PE which he did not explain.

** Looking at PG’s historical data, we can see that 21.00 was its average High PE for the last 5 years, 18.29 was its 2010 High PE, and 19.42 was its average High PE for 2010 and 2009.

** Anything between 18.00 and 20.00 seems reasonable to me

– I decided to use 18.30 because High PEs have been consistently trending down for the last 5 years and 18.30 in 2010 was the lowest and most recent.

Final Results:

– The Ken/Consensus SSG began with a 7.00% EPS estimate and a 20.00 Forecast High PE, and got a Forecast High Price of $106.60 which was well within VL’s estimated High Price range of $90-110.

** These decisions resulted in a 2.12 Upside/Down side Ratio and a 12.58% Total Return, and did not satisfy the SSG Buy Criteria of a minimum 3.0 U/D and a 15.00% TR.

– Armin-1 began with an 8.00% EPS estimate, the lowest of the seven I checked, along with an 18.30 Forecast High PE, and got a Forecast High Price of $102.10 which was comfortably within VL’s estimated range. 

** My SSG also did not satisfy the Buy Criteria as I got a 2.2 U/D and a 11.40% TR.

– Armin-2 is my optimistic SSG and differs from Armin-1 in two respects: I increased EPS to 10.00%, the highest estimate of the seven I checked, and increased the Forescast High PE to 19.4, the average from the last two years.

** Armin-2 got a Forecast High Price of $118.70 which is only slightly, but not substantially, higher than the high end of VL’s $90-110 High Price estimate.

** Here, I almost satisfied the SSG Buy Criteria and got a 3.2 U/D and a 14.6% TR.  However, I am unwilling to increase my EPS any higher because none of the seven estimates I checked were willing to exceed 10.00%.

– Take Stock began with an irrationally low –1.3% EPS estimate (that’s a negative – 1.3%) and a 20.6 Forecast High PE, and got a Forecast High Price of $67.90, some 25% below the low end of VL’s High Price estimate.

** I use Value Line as a test of the reasonableness of my judgments as I never want to be substantially above or below VL’s High Price estimate.  Here, 25% below VL’s low end seems foolish and patently unreasonable to me.

** See: Determining What’s Reasonable and What’s Not [click here]

Competitors:

– Morningstar identified four close competitors, two of which are publically traded: Colgate-Palmolive (CP) and Kimberly-Clark (KMB).  The two privately held competitors are Unilever and L’Oreal.

– Yahoo-Finance also identified KMB as a direct competitor as well as Johnson and Johnson (JNJ) which Morningstar categorizes in a totally different industry, Drug Manufacturers-Major.

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

– Morningstar places Proctor & Gamble in the Household and Personal Products Industry which consists of 36 companies.

– PG’s 5 year average PTPM is much better than its industry average (19.00% vs 10.40% industry) and ranks 3^nd out of 36.

** Colgate-Palmolve, a close competitor, ranks 2^nd with a PTPM of 20.1%; Kimberly-Clark, another close competitor, ranks 12^th with a PTPM of 12.40%.

– However, in terms of ROE, several companies substantially distort the industry average and I eliminated 5 as outliers that had a ROE of 50.00% or greater.

– As a result, PG’s 5 year average ROE is almost identical to its adjusted industry average (15.70% vs 16.00% industry with 31 companies). 

** Colgate-Palmolive had the best ROE at 88.70% in the industry and Kimberly-Clark was 33.20%, both of which were much better than PG’s 15.70%.

** When Ending Equity is used, PG’s ROE (15.70%) is trending up and is even higher and better with Beginning Equity (21.50%), but that ROE is trending down.  ROE or PTPM downtrends are never good.

### The downtrend disappears if 2006 (41.20%) is eliminated as an obvious outlier.

### No Beginning Equity comparisons are possible as the Morningstar industry stats are only for ROE with Ending Equity.

Financial Condition: 

– Value Line gave PG an A++ for Financial Strength, its highest rating.  VL also reported that the company had $32.5B total debt, $21.3B long-term debt, and a 16.9x interest coverage as well as
$.33B in Cash Assets as of 12/31/2010, up 11% for the year.

– Morningstar found that PG has a “rock-solid” balance sheet and reported that it generated $16B in cash from 2010 operations, had an interest coverage ratio of more than 17 times earnings before interest and taxes, and gave it an A++ credit rating.

– SSG data for PG shows that it has a debt to equity ratio that declined from 62.9% to 35.0% in the last five years; free cash flow per share that increased from $2.65 to $4.20 during the same period; and $31.4B in total debt as well as a 34.3% debt to total capital ratio.

– The Analyzing the  Annual Report spreadsheet by Bob Adams got a 59 out of 100 after analyzing PG’s 2010 A.R. with 12 Bullish findings (good things) and 6 Bearish (not-so-goods):

** The Bullish results included: return on free cash flow was very good and got a green flag; interest coverage (16.9x) was also very good and also got a green flag; sales were increasing and increasing faster than related costs; and accounts receivable, inventories, and shares outstanding were all decreasing.

** The Bearish results included: debt to equity (35.0%) is high and may be excessive as Bob says less than 25% is normal; sales are growing slower than cash flow; and free cash flow margin at 10.0% should be higher as anything less than 10 is bad news according to Bob.

– You can get a link to this free and easy-to-use spreadsheet and a description of its many features by going to my Favorite Links page. [click here]

Final Thoughts:

– PG is not a growth company: its sales and EPS growth has been declining for the past ten years and has been negative for the past two.

– PG is not a SSG Buy at its current price, not at an estimated EPS growth of 7.00%, or 8.00%, or even 10.00% for the next five years.

– PG is popular with Better Investing members and ranks #8 out of the top 100 stocks as of the April 2011 issue of BI magazine.

Armin