Stockwatch: Proctor & Gamble - September 19, 2009

Recently, Proctor & Gamble stock has been on the move, reaching $57.32 this last Friday (up $1.79 that day). For most of the last year, P&G has been a disappointment. Since late April, P&G had been stuck in the $50-56 range. While the market has rallied nearly 60% off the March lows, P&G has only risen 27%. In early August, P&G reported 4^th quarter earnings of 80 cents a share, beating expectations of 79 cents a share by a penny but down from last year’s 92 cents a share. In addition, P&G forecast first organic sales growth of 0 to -3%. The stock immediately dropped from about $55.46 to $51.46 a couple days later.

Traditionally, P&G has been considered a solid defensive stock, one to buy in times such as the last year. However this time, P&G has been hit by two distinct problems. First, high commodity prices significantly increased costs, leading P&G to raise prices and to shrink its packaging. This led to the second problem: customers started to trade down – and have stayed there. As a result, P&G has been losing market share.

Now P&G is starting to sing a new tune. Here’s the new news:

- The new CEO, Robert McDonald, took over from A.G. Lafley, the man who drove P&G’s acquisition of Gillette as well as the push toward faster growing, higher margin businesses. For Mr. McDonald, who took over on July 1^st, the fourth quarter (P&G reported 4^th quarter results the first week in office) was just at the beginning of his term.

- For 1^st quarter 2010, P&G still estimates $0.95 - $1.00 in earnings and the Street is at $0.97. Organic growth is still expected to be 0% to -3%. However, for the second quarter, Mr. McDonald anticipates 1-4% organic sales growth. Second quarter will begin in October, 1^st quarter reports should be in the beginning of November.

- P&G sold its drug business to Warner Chilcott fror $3.1 billion on August 24. This is a good sign, meaning P&G is focusing on it’s core businesses.

- P&G has long feared cutting prices on its premium products, but in recent weeks, the company has announced its willingness to cut prices and to reposition its brands. This reflects – finally – a recognition that the landscape has changed, and that price cuts will be necessary to bring back volume and growth.

- The company reaffirmed 2010 earnings of $3.99-$4.12 for 2010. This includes a one time $0.44 benefit and a $0.10 – 0.12 dilution from the sale of its pharmaceutical business. Before, analysts were expecting $3.65 - $3.80.

With the stock trading at $57.12, this places P&G’s current valuation at about 14x 2010 earnings (excluding the benefit from the Warner Chilcott sale and using $3.80, P&G would trade at 15x 2010 earnings). Compare this to the current S&P index, which stands at 1068 and has projected earnings of $72.96 for a 14.6x PE. Debates about S&P projections aside, P&G still trades at a slight discount to the S&P today.

How far can P&G stock go? In the short term, assuming P&G keeps pace with the general market, a 15x multiple on $4.05 2010 earnings would place the stock at $60.75. If we use Colgate Palmolive’s 16x PE ($76.10 / $4.77 = 16x), then P&G would trade at $64.80.

In the longer term, if P&G can return to the days of 6-9% growth and a premium PE of 22x (22x from 2004-2007; as high as 40x from 1999-2001), then we’re talking a stock that would be $80-90 (a conservative $3.80 x 22 PE = $83.60).

Still, that would be some time away. Right now, we’re looking at the likelihood that P&G has seen the trough in sales and the expectation that it can regain growth and stabilize share. Proof, via performance in Q1, would go a long way toward rebuilding confidence and creating upward momentum.

Ming is long PG.