Markets & Finance

Marcial: Procter & Gamble, Durable in a Downturn


A robust return on equity, steady earnings growth, and recession-resistant products make the consumer-goods titan a strong defensive play

In these scary times—when many companies are ratcheting their sales and earnings guidance lower—where do investors turn for stability and predictability? Only a few of the mightiest of the blue chips have been able to weather the global financial crisis and economic recession without big hits to their earnings power.

Procter&Gamble (PG), the world's largest consumer-products company, is one of those few. "P&G's perfect marks for price stability and earnings predictability, and its healthy dividend yield, make it a valuable holding in a diversified portfolio," says Orly Seidman, an analyst with independent investment research outfit Value Line (VALU).

Known for such consumer standbys as Tide laundry detergent, Pampers disposable diapers, and Duracell batteries, P&G has demonstrated over the years that regardless of economic conditions, it can deliver steady returns on equity and predictable earnings growth year after year. That's no easy accomplishment,

Strong Return on Equity

"P&G has withstood the economic headwinds a little better than the rest of the crowd," says Eric Schoenstein, co-manager of the Jensen Portfolio (JENSX) fund, which concentrates its stock holdings in companies that have posted a yearly 15% return on equity (ROE) in each year over the past 10 years, A stock doesn't get into the portfolio unless it has met this hurdle. A strong ROE, explains Schoenstein, is one of the key qualities a company must have to sustain its competitive advantage—and earnings growth—over the years. With P&G sustaining such a solid performance in good or bad economic times, it exceeds this basic measure, he says.

Certainly the financial crisis and economic downshift have had an impact on the stock, but to a lesser degree than other companies' shares. Trading at a 52-week high of 75.18 a share on Dec. 12, 2007, the shares had slid to 61.44 by Dec. 2—a 27% decline, vs. the 40% plunge in the broader market.

The drop has made P&G an even more attractive investment, says Schoenstein, as "it has further widened the gap between the stock price and its intrinsic value." While the shares have fallen, the company's earnings growth has continued to advance, he says.

The consumer-products titan advertises that "3 billion times a day, P&G brands touch the lives of people around the world." But that doesn't necessarily guarantee Wall Street is bullish on the stock. Many analysts warn that sales of consumer products could dry up in a downturn. That's one reason why just about half of the 21 analysts who follow the company recommend buying the stock, while the other half suggest holding it, according to data from Bloomberg. None of the analysts in the group rates the stock a sell.

Investing in P&G "takes a lot of the risks off the table," says Schoenstein. Based on the company's accelerating earnings growth and steady generation of a significant amount of free cash flow over the past 10 years, he contends its real worth is much higher than its current stock price. One reason behind the steady rise in sales: Many of the company's products are recession-resistant, or stuff people need in their daily lives such as beauty products, food, baby products, soap, detergents, and batteries.

Biggest Customer? Wal-Mart

Over the next several years, "P&G is expected to deliver consistent sales and earnings growth near the high end of its peer group," says Loran Braverman, an analyst at Standard & Poor's, who rates the stock a strong buy. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP.) Demand from developing countries for P&G's household and personal-care products is one source of growth, he says, helped by the company's broad product portfolio and sizable distribution network.

North America is the biggest market among the more than 180 countries in which P&G operates. Some 44% of sales come from that region, with 30% from developing countries, 22% from Western Europe, and 4% from Northeast Asia. In the U.S., Wal-Mart (WMT) accounted for 15% of the company's sales. Among products, fabric care and home care generate 28% of sales; beauty products, 22%; health care, 18%; family care, 16%; and grooming, 10%.

With equity prices gyrating wildly, how much is P&G's stock really worth? Braverman's 12-month target is 78 a share, based on a "blended valuation" that takes into account a projected price-earnings ratio of 21, which is near the company's 10-year median; a strong record of earnings growth; the leading market positions of its products; and the analyst's own earnings forecasts.

Talented Management

For fiscal 2009 (ending June 30), Braverman projects earnings will rise to $3.73 a share from $3.64 in fiscal 2008. That excludes a 50¢-a-share gain from the merger of its Folger's coffee unit with J.M. Smucker (SJM).

One way P&G is able to manage its consistent profit growth is partly through a "tenured and talented management team" that makes sure the company has a solid balance sheet and a plan for sturdy earnings prospects, says Jensen Portfolio's Schoenstein. Management is constantly assessing its portfolio of products to make sure they are in the right growth markets at the right time, he says.

The only question to ponder is: With P&G's track record of stable performance and earnings predictabilty—and its attractive dividend yield of 2.5% —why aren't more analysts bullish toward the stock?

As we mentioned earlier, some P&G watchers remain uneasy about the current economic environment. Well, they would do well to heed the words of P&G bull Joseph Altobello, an analyst at Oppenheimer (OPY) who rates the stock outperform, with a 12-month price target of 73. His take: "We are confident P&G can successfully manage through the current macroeconomnic environment, while its staples-oriented product portfolio should prove adequately defensive in a period of slowing consumer spending."

Indeed, P&G's premier virtue is that it is a classic defensive stock, well positioned for an economic downturn. And it should do nicely when the economy recovers—whenever that is.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.


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