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Why Procter & Gamble Surged Higher On Friday?

August 03, 2014 | About:
Faisal Humayun

Faisal Humayun

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I have always liked Procter & Gamble (PG) as a company and the stock has been a value creator for investors over the years. Even today, the company offers a strong dividend yield of 3.2% and the stock is a low beta stock, which is ideal in stretched market valuations.

However, over the last one year, Procter & Gamble stock has remained stagnant even when the company had continued to create shareholder value through dividends and share repurchase. This article discusses the reason why the stock surged by 3% on Friday and the near-term outlook for the company.

Procter & Gamble, in an effort to boost profits and lower costs, has decided that it will sell 90-100 brands whose sales have not been robust in the recent past. Also, the brands that are being considered for sale are non-core brands and do not contribute significantly to the company’s growth.

In aggregate, the sales of these brands have been declining at 3% per year with profits declining by 16% in the past three years. It therefore makes good sense to do away with these brands.

According to the company, it will focus on 70-80 core brands that account for 90% of sales and more than 95% of profits in the last few years. I believe that this is an excellent strategy and as the sale of non-core brands takes place over the next 12-24 months, the stock will move higher.

The most popular brands of the company include Gillette, Pantene, Oral B, Olay, Old Spice, Pampers nappies and Tide detergent. The sale of non-core brands will allow P&G to focus more on the marketing of these core brands and increase the market share.

Another positive factor in the company’s results and announcement was the progress the company has been making in terms of cost reduction. According to the company, the annual manufacturing productivity improvements are ahead of the company’s targets and this implies that margins will keep on improving gradually.

The company has also provided guidance for 2015 and the company expects to grow at low-to-mid single digit range in fiscal year 2015. The expected growth is certainly not extraordinary, but the non-core product sale initiative will ensure that the company’s growth is more robust in the years to come.

From a value creation perspective, the key point is that P&G generated $10.8 billion in free cash flow in 2013 and $10.1 billion in 2014. Therefore, the company has big resources in hand for dividends and share repurchase.

The company’s dividends did increase from $6.5 billion in 2013 to $6.9 billion in 2014 and I expect the dividends to continue increasing. Also, the sale of non-core products will result in further cash inflow for the company and that can be used for share repurchase or special dividends. The company expects share repurchase for 2015 to remain in the range of $5 billion to $7 billion. These likely positive factors have contributed to the stock surge on Friday.

Finally, in terms of valuation, P&G is trading at a forward PE of 16.4. This is relatively higher as compared to a forward PE of 15.8 for Johnson & Johnson (JNJ) and a forward PE of 15.9 for Kimberly-Clark Corporation (KMB).

However, PG& is attractive as compared to peers on a PEG (5-year forward) basis. P&G is currently trading at a PEG of 2.05 as compared to 2.38 for JNJ and 2.53 for KMB. Even in terms of dividend yield, P&G is ahead of peers with a current dividend yield of 3.2% as compared to 2.7% for JNJ and 3.0% for KMB. Considering the valuation and the recent announcement, Procter & Gamble does look like an attractive stock to consider.

In conclusion, the markets were looking for more value creation initiatives from Procter & Gamble and the non-core product divestment announcement comes at the right time. The stock surged by 3% on Friday and the upside is likely to continue as asset divestment is initiated. Investors can consider this value creator stock at current levels.

Also, with market sentiments depressed, it might make sense to remain invested in a low beta stock. Procter & Gamble currently have a beta of 0.4.

About the author:

Faisal Humayun
Senior Research Analyst with experience in the field of equity research, credit research, financial modelling and economic research

Rating: 4.0/5 (1 vote)

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