pg valuation analysis project final

Procter & Gamble, Co. (PG)

Valuation Analysis

MBA 517

Advanced Corporate Finance

Union Graduate College

Jim Scott

Luitpold Staudigl

Dave Stone

March 12, 2009

Procter & Gamble Valuation Analysis 12-Mar-09

Table of Contents

Company Overview.................................................................................................................................. 2

A. Is P&G a Good Company?................................................................................................................... 3

Ratio Analysis....................................................................................................................................... 3

Board Structure.................................................................................................................................... 8

Conclusion.......................................................................................................................................... 10

B. Is the Stock a Good Value?................................................................................................................11

Calculated Ratios................................................................................................................................11

Compound Growth Rate Dividends (1999-2008)............................................................................11

Compound Growth Rate Earnings (1999-2008)..............................................................................11

Average Payout Ratio, Average Retention Ratio............................................................................11

Average Return on Equity (Source: Mergent Online).....................................................................11

Growth Rate Retention...................................................................................................................12

Estimated Growth Rate..................................................................................................................12

Required Rate of Return (CAPM)....................................................................................................12

Estimated Stock Price using Dividend Discount Growth.................................................................13

Estimated Stock Price using P/E and Projected EPS........................................................................13

Comparing Estimated Stock Prices.................................................................................................13

Compare Model Prices....................................................................................................................... 14

Compare Recommendations..............................................................................................................14

Insider Trading....................................................................................................................................15

Risk Factors.........................................................................................................................................16

Recommendation...................................................................................................................................17

MBA 517 – Winter 2009 Page 1


Company Overview Procter & Gamble, Co. (P&G) is the sixth largest company in the world by market capitalization.

P&G is headquartered in Cincinnati, OH, and has 138,000 employees distributed around the world. The company is a market leader in the Personal Products industry of the Consumer Goods sector. Founded in 1837, P&G has been a perennial top performing company. After starting with soap and candles as their main products, today, P&G offers dominant products across a wide spectrum of markets, including food, soap, pharmaceuticals, and even razor blades. The company’s fiscal year runs from July 1 to June 30. The current market price (as of 06-Feb-08) is $54 with a market capitalization of $158 billion.

On September 2, 2003, P&G acquired a controlling interest in Wella and bought the majority of the stocks through a stock purchase agreement with the majority shareholders. The total purchase price for Wella including acquisition costs was $6.27 billion. It was funded through cash, debt and the liability recorded under the Domination Agreement.

P&G bought Gillette in 2005. The company paid 0.975 of a share for each share of Gillette. This increased the number of shares outstanding by 962 million shares. P&G also issued 79 million stock options in exchange for Gillette’s outstanding stock options. The total consideration was approximately $53.43 billion. During 2005 and 2006, P&G repurchased stocks worth $20.10 billion. The repurchases were financed by borrowing $24 billion three year credit facility with a syndicate of banks. The Gillette acquisition resulted in $34.94 billion of goodwill. Based on a P&G's closing price of $55.32 per share (when the deal was announced) the deal valued Gillette at about $54 per share — an eighteen percent premium. The deal was ultimately financed through about sixty percent stock and forty percent cash.



A. Is P&G a Good Company?

Ratio Analysis The Mergent Online data service, Yahoo.com’s financial web site, and P&G’s 2008 annual report

are sources used to collect ten years of selected financial data. The collected data has been processed to yield a summary of financial ratios that can be used to assess P&G’s operational and management success over the past ten years. This table shows the ratio data with a column of current industry averages for some of the ratios:

Ratios Ind. Avg. 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999

EPS ($) N/A 3.86 3.22 2.79 2.83 2.46 1.95 1.63 1.08 1.31 1.38

Net Profit Margin (%) 12.1% 14.5% 13.5% 12.7% 12.8% 12.6% 12.0% 10.8% 7.4% 8.9% 9.9%

Dividend per share ($) N/A 1.45 1.28 1.15 1.03 0.93 0.82 0.76 0.70 0.64 0.57

Dividend yield (%) 3.1% 2.4% 2.1% 2.1% 2.0% 1.7% 1.8% 1.7% 2.2% 2.3% 1.3%

P/E ratio 16.9 15.75 19.00 19.93 18.64 22.13 22.87 27.39 29.67 21.74 32.04

Net sales ($ B) N/A 83.5 76.5 68.2 56.7 51.4 43.4 40.2 39.2 40.0 38.1

Return on Equity (%) 21.5% 17.7% 16.0% 21.6% 41.8% 38.6% 34.7% 33.9% 24.1% 29.0% 31.0%

Debt / Equity 1.1 0.53 0.53 0.61 1.39 1.21 0.84 1.09 1.00 0.99 0.78

The history of market price for P&G stock over the past ten years is also useful to see in the table below (note that the prices have been adjusted for a 2:1 stock split in fiscal year 2004):

Market Price ($) 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999

Adjusted for splits 60.81 61.19 55.60 52.75 54.44 44.59 44.65 31.90 28.38 44.06

More detailed analysis of important ratios is shown below, including a comparison to selected current industry averages.



The history of the P&G stock price is presented here since many ratios are based on the stock price. The stock price is now back to its level as of December, 1999, after dropping nearly thirty percent in the recent economic crisis in late 2008. P&G stock has lost much less in value than many companies from other industries (in the financial sector many companies have lost between forty and ninety percent). In the first calendar quarter of 2000, P&G stock price dropped over fifty percent (to below $30), caused mainly by a loss of confidence from investor’s. Procter & Gamble announced in March 2000 that it would not meet its projected first quarter earnings. About $85 billion in market capitalization was lost. Since March 2000, P&G stock price has risen steadily for eight years, surpassing its December 1999 price in early 2008.



The Earnings Per Share (EPS) steadily increased over the years (except for 2001) to nearly $4.00 per share in 2008 (compared to $1.38 in 1999) as did the dividend payment. The dividend yield remained relatively constant over the past years and is below the industrial average. A more detailed fundamental analysis of the development of EPS and Dividends is shown in the Calculated Ratios section below.

The Price to earnings (P/E) ratio has dropped steadily since 2001 indicating the decreasing growth potential of the company. By 2008 P&G’s P/E ratio was very close to the current industry average. While one might expect a very large company like P&G to have a lower P/E ratio than the industry average (given a counterbalancing effect of small firms in the industry), the fact that its P/E ratio is at the average indicates a potential nimbleness that will allow the company greater future growth than might be expected for a company of its size.

P&G was able to increase its sales over the last ten years, which is a very positive signal to the market. Whereas between 1999 and 2002, the sales were rather constant ($40 bn.), they increased to over $80 bn. by 2008. Increasing sales by 100% within six years is quite impressive, especially given the



magnitude of the sales (growing from $40 bn. to $80 bn).

Over its recent period of steady sales growth, P&G was not simply increasing its prices. The growth rate of its sales is much higher than the inflation (change in the consumer price index). P&G was therefore really able to expand its business. The significant increase in sales in 2006 can be contributed to the acquisition of Gillette in late 2005.

The Book Value per share was quite constant at about $5 between 1999 and 2005 and increased to $23 per share in 2008. This development is rather surprising since the plowback ratio was quite constant over the 10 year period. The development is however favorable in the eyes of an investor – if a company has a very high Book Value per share (compared to the price per share), the risk for the investor to lose money may be considered lower (since it is “backed” by “real” value). In this case, however, the reason for the increased Book Value is a significant increase in “Goodwill”



(from $24bn. to $89 bn.). The acquisition of the Gillette company in 2005 was the reason for this significant change ($34.95 billion). Whether the shareholders are exposed to less risk due to the higher Book Value per share may be questioned.

The capital structure of P&G may be analyzed in a little more detail here. The Debt ratio is relatively constant over the last years and has even decreased. Though it is not possible to tell whether this Debt ratio is the most economic for P&G, a constant debt ratio can be considered rather favorable – especially when the sales are increasing in such an astonishing way. The Current ratio is rather constant too. After the acquisition of Gillette, the Current ratio did improve between 2005 and 2006. After 2006, the Current ratio decreased. The reason for the improvement is not known. However, it seems as if the position “Debts payable within a year” which accounts for over $11 bn. is closely linked to the acquisition of Gillette and has the greatest impact on the Current ratio. The 2006 Annual Report stated that the acquisition was partly financed through a three-year debt. We can only speculate about this position. The Debt/Equity changed considerably over the past years but finally decreased (acquisition Gillette). The Debt/Equity ratio of the industry is 1.1. Since it is not known to which extent “Intangible Assets” do contribute to this number in the industry, a general conclusion shall not be given.

The Net Profit Margin has increased over the last few years and is now about sixteen percent above the current industry average. The reason for the decline in the Net Profit Margin between 1999



and 2001 was probably dueo to bad profitability which led to huge stock losses in 2000. The development of the Net Profit Margin is promising.

The earnings before interest tax depreciation and amortization (EBITDA) has increased steadily over the last few years (again, except between 1999 and 2001). The return on assets (ROA), return on investment (ROI) and return on equity (ROE) have each increased between 2001 and 2005 and decreased significantly between 2005 and 2007. They recovered again in 2008. Since the equity did increase significantly (by a factor of four) after the acquisition of Gillette whereas the return increased only moderately it is not surprising that the ROI and ROE were dropping in 2006 and 2007. The ROA decreased less significantly since the assets “only doubled”. Given this background information, the development of the ROI, ROE and ROA should not be considered bad. The careful investor may ask whether the “Gillette” brand is really worth the huge increase in intangible assets.

Board Structure Procter and Gamble had twelve people on its Board of Directors, as of the end of its 2008 fiscal

year (30-Jun-08). Since that time, Margaret Whitman, former eBay CEO, has resigned from the Board.

Director Age Since Job Country Company

Kenneth I. Chenault 57 2008 CEO U.S. American Express

Scott D. Cook 56 2000 Chairman U.S. Intuit

Rajat K. Gupta 59 2007 Sr. Partner India McKinsey

A.G. Lafley 61 2000 CEO U.S. P&G

Charles R. Lee 68 1994 Retired CEO U.S. Verizon



Lynn M. Martin 68 1994 Professor U.S. Northwestern University

W. James McNerney, Jr. 59 2003 CEO U.S. Boeing

Johnathan A. Rodgers 62 2001 CEO U.S. TV One

Ralph Snyderman 68 1995 Chancellor U.S. Duke University

Margaret C. Whitman 52 2003 CEO U.S. eBay

Patricia A. Woertz 55 2008 CEO U.S. Archer Daniels Midland

Ernesto Zedillo 56 2001 Professor Mexico Yale University

In addition to normal Board meeting responsibilities, P&G’s Board members serve on four committees:

Audit Committee Compensation and Leadership Development Committee Governance and Public Responsibility Committee Innovation and Technology Committee

All Directors except P&G CEO and Chairman A.G. Lafley are from outside P&G. According to the company’s 2008 Proxy statement, all Board members except Lafley and Johnathan A. Rodgers, CEO of TV One, qualify as independent Directors based on the NYSE listing standards and the Independence Guidelines. Mr. Rodgers is not considered independent because P&G paid Rodger’s company for advertising time in excess of two percent of that company’s gross revenue for that year. Cook worked at P&G until 1983, before founding Intuit, but after that many years he is considered independent. A review of the companies that these Directors work for or are Directors for shows no overlap in Board memberships except for Scott D. Cook, Chairman of Intuit, who is also board of eBay.

The Board has a reasonable mix of diversity with nine men, two of whom are African American, three women, and two members from outside the U.S. Given the global presence of P&G, it is good to see some non-U.S. citizens on the Board of Directors; however that proportion of Board Members from outside the U.S. (seventeen percent) does not match the proportion of company revenue from outside the U.S. (about forty percent). With such a strong global presence, the Board of Directors might benefit from greater representation and perspective from outside the U.S. P&G’s Board of Directors is dominated by CEO's (or former CEO's) but does include three from academic institutions. The number of active CEO's on the Board should be a concern with respect to time commitment to the company. All Board members are paid an annual retainer of about $100,000 (including extra amounts for committee responsibilities) and annually awarded a grant of restricted stock worth $125,000.

Conclusion Analysis of financial ratios and other measures presented above, plus the make-up of the Board of

Directors, combine to paint a very impressive picture. Procter & Gamble looks like a very good



company that has been able to avoid stagnating over the years and instead continues to grow at a very health rate. The company is impacted like other companies by major recessions, but has repeatedly recovered and been stronger. That seems likely to be the case now as well.



B. Is the Stock a Good Value?

Calculated Ratios To determine the value of a stock, an investor may consider the intrinsic value of a stock

determined by the performance of the company. Several rates and ratios may give the investor a good indication on whether a stock is overvalued, undervalued or fairly priced.

Compound Growth Rate Dividends (1999-2008)

Compound growth rate gD =

Compound Growth Rate Earnings (1999-2008)

Compound growth rate gE =

Average Payout Ratio, Average Retention Ratio

Payout Ratio (2008) = =

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

0.41 0.49 0.65 0.47 0.42 0.38 0.36 0.41 0.40 0.37

Average Payout Ratio =

Average Retention Ratio =

Average Return on Equity (Source: Mergent Online)

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

30.98% 29.02% 24.05% 33.85% 34.7% 38.63% 41.76% 21.61% 15.95% 17.68%

ROEaverage=



Growth Rate Retention

Growth rate retention gR = average RoE * average Retention ratio = 0.288 * 0.564 = 16.2 %

Estimated Growth Rate

g =

The growth rate that can be estimated from the dividends and earnings is quite different from the growth rate that can be derived from the ROE and the average retention rate. In order to find a “more suitable” solution, the arithmetic average of all three is taken.

Required Rate of Return (CAPM)Beta can be calculated through linear regression. The weekly returns of P&G and the S&P 500

were plotted against each other over the same period of time (Jan2008-Feb 2009). If the slope is greater than one this means, that the return of the stocks were bigger than the returns of the market – the stock is considered to be riskier than the market.

For P&G, β = 0.53. This indicates that the company is not a highly risky stock. The required rate of return for P&G according to CAPM is:

Required Rate of return = rf + β * rM = 3.5 % + 6.55 * 0.53 = 6.75%

Estimated Stock Price using Dividend Discount GrowthFor P&G’s situation, the required rate of return is 6.75%, which is less than the estimated



growth rate of thirteen percent based on historical financial data. This means that the constant growth rate model for estimate stock price will not work directly. Instead, the non-constant growth rate model will be used. This model yields anticipated growth rates that will decline over the next couple years to a constant rate of six percent. The historical data for P&G covered through mid-2008 calendar year, but since then the global recession has had a dramatic downward impact on almost all stocks, including P&G. Given current market conditions, our prediction is that growth rates will decline from the thirteen percent in 2008 to eight percent in 2009 and then level off at five percent constant growth from 2010 and beyond. With these assumptions, an estimated stock price for P&G based on discounted dividend growth can be computed:

Estimated stock price P0 = D1 / (1+Rs) + D2 / (1+Rs)2 + P2 / (1+Rs)2

where Rs = 6.75% and g1= 13.0% and g2= 8.0% and gc= 5.0% and D0 = 1.45

and D1 = D0 * (1 + g1) = 1.45 * 1.13 = 1.64

and D2 = D1 * (1 + g2) = 1.64 * 1.08 = 1.77

and P2= D2 * (1+ gc) / (Rs – gc) = (1.77 * 1.05) / (0.0675 – 0.05) = 106.20

so P0 = 1.64 / 1.0675 + 1.77 / 1.06752 + 106.20 / 1.06752 = $96.28 per share.

Estimated Stock Price using P/E and Projected EPSAverage P/E ratio (1999-2008) = 22.9Projected EPS for FY 2009 = 4.225 (based on averaging high and low estimates of analysts on

YahooFinance.com)Estimated market price = 22.9 * 4.225 = $96.75 per share.

Comparing Estimated Stock PricesTwo different stock price estimation models were used above to predict P&G’s market price.

The dividend discount growth model predicts a market price today of $96.28 and estimating using P/E ratio and projected EPS predicts a market price today of $96.75. These two estimates are surprisingly close to each other, given the assumptions made about growth rates in the next few years. However, both estimates are more than double the true current market price of P&G stock, which is just under $45 today (10-Mar-09). The global recession and current pessimism with the stock market in general are the dominant factors in the model price predictions and the actual market price of P&G’s stock. The company continues to pay dividends as in the past (at least for now) and continues to deliver significant return on equity. Investor emotions are clearly the major (and almost only) factor in the difference between model predictions and actual market price. It is worth noting that the stock price history curve on page three suggests that without the current stock market downturn, P&G’s stock price would have probably been near $80 per share, much closer to the price predicted by both models.

Compare Model Prices Over the last three years, the yearly return for the Procter & Gamble stock (based on weekly



returns) was 5.68%. For the ten year period from 1999-2009 the average annual rate of return was 4,58% (based on daily returns). Given the huge losses the stock suffered in 2000, the stock price estimates that were drawn from the fundamental analysis seem to be quite promising. P&G stock would be in a strong BUY position for based on history over the past ten years. However, the dramatic market slide over the past six months (all after our historical data) suggests more caution with respect to buying P&G stock at this time.

A more aggressive investor should consider buying P&G stock at this time. The current market price is just under $45 and our estimation models predict a price closer to $96, so the only reason to hold back is the current negativity in market emotions. Putting emotions aside, we conclude that now is a good time to BUY P&G stock for a long term investment (over five years). Trying to wait and time the stock market’s rebound is unlikely to be successful and given all the strong indicators we have analyzed, P&G is a good company and its stock has been and should be a good value over the long term.

Compare Recommendations Using the Yahoo.com finance website, the recommendation of analysts who follow P&G stock

indicates a preference for HOLD with a mean recommendation of 2.6 where 1.0 means STRONG BUY and 5.0 means SELL. The analysts all seem to have gravitated toward a HOLD position given the extreme negativity in the stock market in general and given all the current economic uncertainties. The general pessimism of these analysts coincides with general pessimism in the market, suggesting this may be close to the bottom and that an investor might start considering buying a strong future performer like P&G stock. The analysts have held the same mean recommendation for over a month now.

RECOMMENDATION SUMMARY (Strong Buy) 1.0 - 5.0 (Sell)

Mean Recommendation (this week):

Mean Recommendation (last week):

UPGRADES & DOWNGRADES HISTORY

Date Research Firm Action From To

2-Feb-09 Caris & Company Downgrade Above Average Average

15-Jan-09 Bernstein Downgrade Outperform Mkt Perform

16-Oct-08 Caris & Company Initiated Above Average

16-Jul-08 BMO Capital Markets Downgrade Outperform Market Perform

17-Apr-08 Deutsche Securities Downgrade Buy Hold



Insider Trading Insider transactions will be analyzed as it relates to the transactions over the past six months of

key executives, as presented below.

Pay ExercisedMr. Alan Lafley , 62Exec. Chairman, Chief Exec. Officer and Pres

N/A N/A

Mr. Robert A. McDonald , 56Chief Operating Officer

$ 2.79M $ 661.00K

Ms. Susan E. Arnold , 55Pres of Global Bus. Units

$ 2.68M $ 1.49M

Mr. Clayton C. Daley Jr., 57Vice Chairman of Special Assignment

$ 2.50M $ 1.06M

Mr. E. Dimitri Panayotopoulos , 58Vice Chairman of Global Household Care Group

$ 2.36M $ 1.08M

Insider purchases over the last six months consisted of no purchases and net sales of 10.1%. Institutional shares held declined by 3.3% over the same time period.

P&G CEO, Alan Lafley, made non-open market dispositions and automatic sales exclusively and there were no incidences of heavy selling or buying of P&G stock. Mr. McDonald, Ms. Arnold and Mr. Panayotopoulos each made non-market dispositions, acquisitions and automatic sales. The only incidence of an insider trade that was not an automated transaction was transactions involving the P&G COO, Mr. Robert A. McDonald. On November 19, 2008, Mr. McDonald sold 2,000 shares of P&G at $64.16 per share. On November 28, 2008, another 2,000 shares were sold at $64.05 per share. Consistent with the other insiders, all other transactions by Mr. McDonald were automatic transactions.

Very little useful information can be drawn from the insider trading of P&G stock except the idea that senior management is confident in the future prospects of the company. Otherwise, there would have been a significantly higher rate of selling of P&G stock over the past six months. Furthermore, going even beyond the past six months, one would still find a general exclusion of sales in the company stock on behalf of executives. Alternatively, one could argue that these are bearish signs because there is no buying – save that of automatic purchases as part of a stock option plan. The information gathered in this analysis will be considered along with the rest of the study in making a recommendation on P&G stock.



Risk Factors The markets in which P&G competes present the company with many risk factors, both internal

to the organization as well as external to the economic environment. As a consumer product company, P&G faces a significant risk concerning the variability of global demand for its products and brands. Additionally, the company must continue to innovate both products and operations in order to remain competitive. This entails obtaining patents that lead to the development of products that appeal to consumers worldwide.

In order for P&G to achieve its business objectives, responding to local and global competitors is a must. P&G faces a wide variety of global and local competitors resulting in ongoing competitive product and pricing pressures in competitors. Cost pressures could affect the company’s business results. P&G’s costs are subject to fluctuations, particularly due to changes in commodity prices, raw materials, and cost of labor, foreign exchange and interest rates. This reality also results in challenges for the company in maintaining profit margins.

P&G’s ability to successfully integrate key acquisitions, such as The Gillette Company, could impact its business results. Acquisitions must be made without any significant disruptions to P&G’s ability to manage and execute business plans on its base businesses. Failing to deliver the expected cost and growth synergies associated with acquisitions could adversely impact P&G’s financial results.

The core businesses of P&G are functioning in a global marketplace and the company faces risks associated with significant international operations. P&G conducts business across the global with a significant portion of its sales coming from outside the United States. Growth must be achieved in developing regions to ensure the continued success of the company. Should P&G’s growth rates or market share fall substantially below expected levels in these regions, its results could be negatively impacted. Additionally, economic changes, terrorist activity and political unrest may result in business interruptions, inflation, deflation or decreased demand for its products.

Another area of risk for P&G is in regulations in the U.S. and abroad of which the company’s business is subject. Changes in laws, regulations and the related interpretations may alter the business environment. This includes changes in environmental, competitive and product-related laws, as well as changes in accounting standards and taxation requirements. According to P&G’s 2008 Annual Report, “our ability to manage regulatory, tax and legal matters…and to resolve pending legal matters without significant liability…could require (P&G) to take significant reserves or pay significant fines during a reporting period, may materially impact our results.”

If the reputation of one or more of P&G’s leading brands erodes significantly, it could have a material impact on its financial results. P&G’s success is dependent on the success of its brands, particularly its billion-dollar brands. This risk will be exacerbated if the marketing plans or product initiatives do not have the desired impact on a brand’s image or its ability to attract consumers. Further, P&G’s results could be negatively impacted if one of its leading brands suffers a substantial impediment to its reputation due to real or perceived quality issues. The Annual Report also states that “(a) material change in customer relationships or in customer demand for (P&G’s) products could have a significant impact on our business.”



Lastly, the success of P&G is dependent on its ability to successfully manage relationships with its retail trade customers, including its ability to offer trade terms that are acceptable to its customers and are aligned with its pricing and profitability targets. P&G’s business could suffer if it does not reach agreement with a key customer based on its trade terms and principles. The continuing trend toward retail trade consolidation leads to more complex work across broader geographic boundaries for both P&G and key retailers. This can be particularly difficult when major customers are addressing local trade pressures or local law and regulation changes. P&G’s business would be negatively impacted if a key customer were to significantly reduce the range of inventory level of P&G’s products.

While these risk factors appear to be extensive and potentially severe with respect to P&G’s business and stock price, the company has an impressive track record of dealing with these risks. The company’s long term success at dealing with and mitigating risks suggests that a long term investor should be comfortable re-examining P&G’s risk factors once a year as part of a portfolio review. Also, by including P&G stock in a well diversified portfolio of stocks would sufficiently minimize potential losses.

RecommendationBased on this analysis, P&G is a good company in terms of management and operational

performance as evidenced by past performance. Given the fundamental analysis of the company’s stock price and the current market conditions, buying P&G stock for a long term investment is recommended. In the short term, P&G should be paying a relatively high dividend yield given its currently depressed stock price and expected dividend per share.


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