Procter & Gamble (NYSE:PG) definitely has a wide moat and seems to be moving in the right direction after its much publicized move into becoming a much more responsive and nimble consumer product manufacturer. Despite the company’s top line having dropped from $82 billion in 2012 to just over $65 billion in 2016, sales are expected to flatten out this year and then grow at a nice clip thereafter.
Sentiment at present in the stock is pretty pessimistic which is surprising when one takes into account how earnings have been growing. In fact, the company’s trailing twelve month earnings average is $5.47 at present which is well ahead of the $3.69 print, the company reported in its latest fiscal year. This really is where investors should be focusing their attention. Why? Because if we go back to 2012 when Procter & Gamble topped out on revenues, the company brought in $10.75 billion in net income with an operating margin of 15.9%. In 2016, the company as mentioned turned over $65 billion but reported $10,508 in bottom line earnings. This number equated to a an operating margin of 20.6% which is the higher operating margin percentage in well over a decade. Lower sales but similar earnings means much higher profit margins which is just what the doctor ordered.
I just feel the market hasn’t benefited the stock as of yet for the turnaround the company is undergoing. Investors should remember that the company has held onto the 60+ brands that essentially made the company and those proven brands already make up over 90% of the firm’s bottom line. By becoming laser focused on where the company feels are its best opportunities will ensure increased productivity as more capital will undoubtedly be put behind core brands in the areas of marketing and innovation.
Emerging markets proved difficult for Procter & Gamble to wrestle with over the past few years and the failure to win market share with new products in these jurisdictions was one of the principle reasons why the company decided to transition. Therefore instead of competing with stiff competition in these markets, P&G will now deploy more of its resources around its winning brands with the aim of renewing products faster and much better than before. Remember that the company is already well established in the blades and razors market and baby care markets to name but a few.
Through elevated cash low and probable better upgrades, Procter & Gamble will continue to market its successful products hard and I don’t buy the argument that the company’s earnings could become capped in years to come due to how successful Procter & Gamble is in some areas. Although the company’s Blades and Razors market share stands at well over 60%, Baby Care stands at 30% or under along with other markets such as Fabric Care and Feminine Protection. Suffice to say that there is still plenty of room to grow in the company’s core brands and because of the elevated focus in these areas, there should be meaningful cost savings to boot.
Technically, when sentiment dropped to pretty bearish levels at the start of this month, the stock rallied back to overbought conditions. We have a very similar setup at present as the stock goes into earnings on the 26th of April next. Analysts are looking for $0.94 which would be a $0.08 gain over the same quarter of 12 months prior. However since sentiment is so mute at present, I believe we have a low risk setup here.
Volatility is relatively mute for option traders as we approach earnings. We may get a further spike up but at present, we seem to be trading (volatility-wise) around the mid point of the range over the past 12 months (14.5%). The premium just isn’t there at present in the options to justify long exposure. We are still dealing with a $90 stock here so any option contract is going to be potentially worth $9,000 if one takes possession of the shares.
However I just feel that this company has been caught up in the struggles of the consumer products industry and is trading lower than its fundamentals state at present. Analysts are expecting earnings growth to increase over the next three years at least which is bullish from a share price appreciation point of view. The real question is how does one value the new streamlined Procter & Gamble. With a present forward price to earnings ratio of 21, its valuation is only slightly ahead of where the the S&P500 (NYSE:SPX) is trading at present. However with a dividend yield of over 3% and a very strong balance sheet, I would argue that Procter & Gamble is a better play than the general market at present. Why? When stocks make strong trending moves like we are seeing at present, you want to be long underlyings with strong balance sheets and strong competitive advantages. Procter & Gamble ticks the boxes here because of the momentum it has built in metrics such as earnings and margin growth. A long bullish stock position prior to earnings looks to be the best set-up here.