Procter & Gamble’s Stock Looks Overheated After Effectively Weathering Headwinds in the Quarter

Procter & Gamble Stock at a Glance

• Current Morningstar Fair Value Estimate: $125
• Procter & Gamble Stock Star Rating: 2 Stars
• Economic Moat Rating: Wide
• Moat Trend Rating: Stable

Procter & Gamble Earnings Update

While we believe Procter & Gamble’s (PG) second-quarter results (5% organic sales growth and modest degradation in gross and operating margins) suggest it’s withstanding macro and competitive challenges quite well, we are less sanguine on shares at current levels. With six months in the rearview, we see little to warrant altering our near- or long-term outlooks for the business, but our $125 fair value estimate should see a low-single-digit bump on time value. Shares trade at a 15%-20% premium to our intrinsic valuation, but if a more attractive entry point comes to fruition (likely on economic concerns), we’d be eager buyers.

Critically, volumes slumped to the tune of 6%, offset by an 11% benefit from higher prices and favorable mix. However, we don’t believe the headline numbers tell the whole story; half of the volume pullback was reflective of P&G’s decision to ratchet down its Russian business and due to temporary retail inventory reductions (particularly in China) rather than deteriorating consumption trends.

Further, we surmise the 160-basis-point downdraft in gross margins to 47.5% is primarily a byproduct of stepped-up commodities, unfavorable mix, and investments in capacity (650-basis-point headwind, with another 60-basis-point hit from foreign currency). But P&G isn’t sitting still, as pricing and productivity savings served as a 550-basis-point offset, and we suspect management will remain resolute in these initiatives.

In this vein, management alluded to the potential for additional price hikes (with the next round slated for February), but we don’t believe P&G will waver in its commitment to funnel resources to its brands (innovation, marketing, and increased capacity)—even though costs have inflated. This stands to support the brand intangible assets that underpin its wide moat and ensure volumes hold up over a longer horizon. As such, we forecast research, development, and marketing to amount to 13% of sales annually over the next decade.