P&G Shares Still Not Attractive
Procter & Gamble took a step in the right direction last quarter, but the true test regarding the sustainability of this improvement remains, says Morningstar's Erin Lash.
Procter & Gamble took a step in the right direction last quarter, but the true test regarding the sustainability of this improvement remains, says Morningstar's Erin Lash.
Procter & Gamble (PG) has been plagued by an erosion of pricing power, setbacks in its emerging-market growth strategies, and a bloated cost structure, but first-quarter results (which included modest sales growth and margin improvement) were a step in the right direction. We still contend that P&G has a long way to go down the road of driving sustainable improvement. For instance, in China, the firm lost market share (posting just 7% growth in the quarter compared with 11% market growth). Management maintained its initial fiscal 2013 forecast for sales growth of just 2%-4% and core earnings per share of $3.80-$4.00, but increased its reported EPS guidance by $0.17 (to a range of $3.78-$4.02 to reflect a gain on the buyout of the rest of its baby- and family-care joint venture in Iberia).
While we may take our fair value estimate up slightly to reflect recent results as well as additional cash generated since our last update, we don't view the shares as an attractive value proposition at their current market price. The shares have trended higher over the past several months following the announcement that activist investor Bill Ackman had accumulated around 1% of the shares outstanding. Ackman has yet to show his cards, but we have little doubt that he would like to push for change to unlock additional value from this household and personal-care behemoth, whether through a management shakeup, further cost-efficiency efforts, or strategic alternatives such as selling noncore brands or splitting up the business.
First-quarter sales ticked up 2% after adjusting for foreign currency movements, acquisitions, and divestitures. Excluding the beauty-care business (where organic sales fell 2%), the four other segments (grooming, health care, baby and family care, and fabric and home care) generated low-single-digit underlying sales growth. Productivity savings combined with higher prices (which offset unfavorable mix--that is, greater sales from developing markets) resulted in 80 basis points of adjusted gross margin expansion to 50.6% and a 90-basis-point increase in adjusted operating margins to 20.7%. The $10 billion cost-saving initiative P&G announced in February is designed to lower costs at the firm, primarily through reduced overhead, improved material costs from product design and formulation efficiencies, and increased manufacturing and marketing productivity, and we wouldn't be surprised if the firm looked to realize additional efficiency gains. Although we agree that P&G needs to lower its costs, we think more reinvestment will be needed to keep market share healthy, and recent commentary by management suggests that it agrees with our take. As a result, we don't anticipate material margin expansion over the near term.
Following the announcement last quarter that it would repurchase $4 billion in shares (about 2% of shares outstanding) this fiscal year (which ran in contrast to comments earlier this summer that it would suspend its repurchase program to ensure its AA credit rating held), P&G repurchased $2.6 billion of its shares in the first quarter. While we think this could reflect P&G's attempt to return additional cash to shareholders and keep activist investors (like Ackman) at bay, we'd prefer to see the company to take a more opportunistic approach and get more aggressive with repurchases at a price below our fair value estimate.
We are attending the firm's analyst day in Cincinnati next month and hope to get additional details on P&G's plans with respect to cost cutting as well as innovation, which has been lackluster for some time. In addition, we will be looking to get a better sense as to the depth of the firm's management bench. In our view, the tenure of the current management group could be cut short if steps forward aren't realized sooner rather than later, and we foster some concerns that P&G (which tends to promote from within) may not have anyone to fill the top spot if it were to become vacant, given that several senior executives have headed for the exits over the past several years.
Morningstar Premium Members gain exclusive access to our full Procter & Gamble Analyst Report including fair value estimate, consider buying/selling prices, bull and bear breakdowns, and risk analysis. Not a Premium member? Get these reports immediately when you try Morningstar Premium free for 14 days.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.