Goodwill – We projected to be flat for the foreseeable future due to the fact their last major acquisition was Gillette in 2005.
Based upon our forecasts for P&G, we have placed a HOLD rating on the stock given its current trading levels. Using the Exit Multiple, Key Driver, and FCF approaches we have projected a stock price for P&G in the $82 to $83 range indicating approximately a 5-6% drop in price from its current closing price of $87.25.
The most recent Q3 earnings call for PG did not meet our expectations. The company is still facing headwinds primarily due to foreign currency and competition. Sales in Q3 were slightly down (-1%) year-over-year, reflecting yet another quarter of negative revenue growth as P&G is restructuring its business to focus on key markets and sheds less profitable product categories. The divesture of 41 beauty brands to Coty Inc., which was completed in October 2016, negatively impacted overall revenue growth by 2 percentage points. However, the strongest negative contributor to revenue growth in the quarter was the Grooming segment, which presented a 6% drag on overall revenue growth due to unfavorable product mix (-4%) and challenging pricing (-2%). A bright spot was the Health Care segment, which contributed 4% to net sales growth, driven by higher volumes. The results of Q3 are incorporated in our TTM, which has been a large determinant of our estimated sales growth for fiscal 2017.
As noted from PG’s CFO, a good year for PG is between 1-3% all-in sales growth and a great year 3-5% all-in sales growth. In terms of their current strategy, product innovation and repeat customers are key for PG’s developed markets especially the U.S. PG forecasted “organic sales growth for its U.S. market to be about 2% for the first half of FY 2017”[footnoteRef:1]. Internationally, PG sees China as its biggest opportunity with their growth drivers set on “premiumization of our brands, digital execution, transforming our Go-To Market, and dedicated category- customer organization”[footnoteRef:2]. [1: PG CAGNY 2017 Presentation] [2: PG 2016 Analyst Day Presentation]
In PG’s FY 2017 guidance, foreign currency is expected to be “2-3% drag on the company’s all-in sales growth resulting in their expectation for FY 2017 to be flat”[footnoteRef:3]. We feel foreign currency is going to continue to be a headwind for PG due to the outlook of rising U.S. interest rates driving the strength of the USD. Internationally, China has become a concern due to PG losing market share in the country “primarily driven to the Baby Category”[footnoteRef:4]. Political unrest in Brazil and Venezuela along with trouble in economies that are dependent on oil make us feel international sales growth will still be a challenge. Analyst research has reflected closer to 2-3% growth per year based on the full restructuring succeeding & emerging market pickup. We forecast PG can remain flat in ’17 and adjusted down our future estimates due to foreign currency (as US interest rates are expected to continue to rise), softness internationally in sales, and industry /population growth trends. Our estimates are .40% in ‘17, 1.4% in ‘18, 1.9% in ‘19, 2.3% in ‘20, 2.7% in ‘21. (see segment for more detail) [3: PG Q3 2017 Earnings Presentation] [4: PG Q3 2017 Earnings Transcript]
Our sensitivity analysis most definitely had an impact on our investment decision, particularly when looking at WACC vs Growth. When WACC was above 6.5%, our decision would have changed from “Hold” to “Sell” in all growth cases. When WACC was 5.3% our decision would have changed from “Hold” to “Buy” in all growth cases. As we see more upside risk in WACC give current economic conditions, we stayed in the “Hold” camp unless the EV/EBITDA multiple dropped below 12.70 then we would have placed a “Sell” rating on PG.
The EV/EBITDA multiple we chose was 13.2 implying a 2% growth rate. In comparison to Colgate-Palmolive which our speaker described as PG’s closest competitor, our 13.2 multiple is more conservative than Colgate’s multiple of 15.98. We feel 13.2 is a realistic assumption due to PG’s 5-year average being 13.21 and 13.2 being slightly in the middle between its median level EV/EBITDA multiple of 12.03 and it’s all time high of 14.28. This multiple also implied growth between 1.5-2% terminal growth which is in line with our assumptions.
Outline Format:
A.
· Tax rate – We researched the historical tax rate and observed slight increases from 22% in 2011 to 25% in 2016. We feel tax reform by the Trump administration is ways away from becoming legislation due to political gridlock; therefore, we decided to keep the effective tax rate constant at 25% to keep the forecasting consistent with future years.
· Sales Segment Growth– The sales segment growth was based off our trailing twelve month assessments. We forecast growth rates to remain the same in FY ‘17, for each segment to keep results slightly above flat. For the future years, we see Fabric generally increasing about a .5% to 1% due to increased market penetration of fabric enhancers and beads. We see health care continuing to excel at a nice pace with growth plateauing at 4.5% based in industry expectations. We see the bleeding in Grooming stop in FY ‘20 and return to growth as the product pipeline is strong, which is slightly pessimistic to analysts who view Grooming returning to growth in FY ‘19. (Factset). We see Beauty marginally increasing each year plateauing at 2% in FY ‘19 due to stabilization from brand divestitures as part of the COTY deal. Beauty worldwide has been strong as evidenced by the international sales in this segment. We also see pricing power in this segment as the products remaining have stong brand loyalty and units sold are strong. Finally, for Baby, Feminine, & Family, we view this segment returning to growth in FY ’18 and plateauing at 2.5% in FY ‘20; however, we are nowhere near as optimistic as analysts “2.71% in FY ‘18” due to concerns with China as we mentioned in the Baby Category.
· Gross Margin and Operating Margin – PG went through large restructuring changes previously, but now that those changes appear to be finished (we adjusted past years to see actual margins wo these costs), we don’t predict more restructuring in their future. We also didn’t assume impairments as well. All other operating expenses we assumed in our forecasts. However, PG has announced that they will be implementing a new “$10 billion productivity and supply chain program from 2017 to 2021”[footnoteRef:5]. This new program is meant to streamline supply networks across the United States and create a more direct way to link PG to their customers. Because of this and analyst research, we see gross margins and operating margins increasing to 52.55% and 24.75% by FY ‘21. We aren’t nearly as optimistic due to foreign currency concerns driving up costs internationally and increased R&D spending incurred so the company can continue to innovate to improve sales growth. We forecast gross margins increasing .25%-.5% each year to 51.25% and Operating margins rising .2%-.5% to 24.2% by FY ‘21. We also see the higher margin healthcare and beauty division driving some of this growth now that the product line has been paired down. [5: PG 2016 Annual Report]
· Growth rate– We presumed a 2% long term growth rate for PG. Historically the U.S. economy has been growing at about 2-2.5% and we don’t see PG being able to outperform the U.S. economy. Also, PG reported weakness internationally as we mentioned earlier in our report; therefore, we are being moderately conservative with a 2% terminal growth rate. This also aligns with industry research as consumer staples will tend to grow with GDP are not very volatile to economic trends.
· ROIC– Our terminal ROIC projection is 12.4%. We see NOPLAT rising slightly $400M each year offset $3 billion of increased capital needs; thus, causing ROIC to grind slowly up to 12.4%. This estimation is slightly higher than the PG’s 6 year average ROIC of 11.07%. still pretty conservative as the restructuring is showing signs of success thus returning the Company to higher ROI.
· EV/EBITDA multiple– Our estimation for this multiple was 13.2. We determined this was by looking at the average EV/EBITDA ratios and its closest competitors. Terry from PG mentioned Colgate- Palmolive as a close competitor with a EV/EBITDA of 15.98; however, we feel this is too high because PG’s multiple has never reached 15.98 historically. We chose 13.2 because it’s a more appropriate near PG’s 5-year average of 13.21 and given the restructuring is almost complete, we feel this is in line with the future growth of the firm.
· Operating Cash – For Operating cash as % of revenues we chose 5% because it closest to the industry standard of cash as percentage of revenues excluding PG. PG is a bit of an outlier with their cash being historically about 8.95% on a 5-year average.
· Goodwill – We projected to be flat for the foreseeable future due to the fact their last major acquisition was Gillette in 2005.
· Capex– We estimated capital expenditures to stay approximately 5%-6% of sales. Historically and as mentioned in PG’s FY ‘17 presentation CAPEX is “expected between about 5%-5.5% of sales.”[footnoteRef:6] [6: PG Q3 2017 Earnings Presentation]
· PP&E and NWC– We see PP&E ramping up from 31% in ‘17 to 35% in ‘21 as the firm continues to expand overseas. As the restructuring is stated to end next year, NWC needs will increase due to restructuring being over and the company needed new equipment as well for growth and as part of their planned supply chain overall.
· DSO-We estimate that our DSO ratio slightly increases in our forecasting years returning to average levels of 27 days in 2021. We attribute the prior years due to declining sales and divesting brands equating to less accounts receivable.
· DIO– We forecast DIO increasing back to normal averages of 58 by 2021. We attribute the precipitous drop in inventory from 2014 to 2015 that stayed consistent in 2016 due to divesting businesses. We see inventory picking back for our future expected sales growth forecasts.
· DPO-Our DPO ratio shows our accounts payable decreasing steadily to the 5-year average of 80 by 2021. FY 2016’s DPO of 100 days appears to be an outlier when looking at the company’s historical operating cycle. DPO was 100 days just once in 2016 out of the past 15 years of historical data. Much of this was due to their restructuring efforts and with the Company returning to more efficiency overall, this will improve DSO, DIO and DPO
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