🧼🪥Business Overview

🎯Key Metrics

Total: 9.5/17

• +2 ✅ Projected Operating Margin: 21.00%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 3.00%
• +1 ✅ Last 5-Year ROIC: 16.84%
• +1 ✅ Estimated Cost of Capital: 8.32% (less than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -0.88%
• -1 ❌ Projected 5-Year EPS CAGR: 2.56% (given the ease of manipulating earnings metrics, sub-10% growth warrants caution)
• +0 ⚠️ Projected 5-Year Dividend CAGR: 4.69%
• +1.5 ✅ Moody’s Rating: Aa3
• +2 ✅✅ Morningstar Moat: Wide
• +2 ✅✅ Morningstar Uncertainty: Low

Procter & Gamble operates within a very competitive environment. However, its higher operating margins and wide moat its a clear sign it still operates with competitive advantages over its competitors as well as it has the capability of raising prices if needed. Also, it’s always good to see that it still returns on its investments (ROIC) double its cost of capital, showing good capitall allocation by management.

Despite this, I feel the future for this company still holds some friction by the appearance of fierce competition, pressuring Procter & Gamble to reduce its prices and by consequence its operating margins. Also, unless something exceptional happens, given the maturity of the business, I see its revenues grow below or at the economy growth rate.

Please note these are only my assumptions, taking into account the current state of the business, analyst projections and my own thoughts on the company. I will proceed to explain them in more detail below.

As a little disclaimer, I would add that I normally use these key metrics to help me allocating capital over my investment portfolio, however take everything here with a little grain of salt. I will guide you through all my thought processes as well as provide you tools to override/change everything and come up with your own value for the company but as with anything, take responsability for your own investment decisions.

📈Business Valuation

Before presenting you with a final and empty number, I will show you first my own assumptions, as well as the historical data and analyst projections that led to that. My real objective here is to write down my valuation thoughts and, hopefully, in the process learn and help you learn something new.

Revenue Growth

Below is the last ~10 years of revenue growth for Procter & Gamble:

💡Given the maturity of the business and its historical data, I believe the company will grow it’s revenues at around ~3% and for simplicity sake converge to the economy growth rate ~4.69% (here I’m using the 10 Year U.S. bond rate as a proxy to it).

Cost of Capital

I’ve used the latest annual report of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 8.32%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Also, keep in mind that the average cost of capital in the US for a company similar to Procter & Gamble in the Household Products industry is ~7.03%.

💡My assumption for the cost of capital is that it would remain at the current values ~8.32% given the maturity of the business.

Later, we will explore some variability over these values by using the Monte Carlo simulations, exploring for example if Procter & Gamble converges its cost of capital to industry values or even if it has a higher cost of capital.

Operating Margin

Procter & Gamble has its revenues distributed between 5 main business segments (we are excluding the corporate one):

Fabric & Home Care: 34.8%

• Fabric Enhancers, Laundry Detergents, Air Care, Dish Care, etc.
• operating margin: 24.0%

Being the business segment where the company gets most of its revenues (around 1/3) the Fabric & Home Care has remained very stable over the last couple of years. It does not show signs of expansion or contraction in its operating margins.

Baby, Feminine & Family Care: 23.4%

• Baby Wipes, Menstrual Care, Paper Towels, Tissues, etc.
• operating margin: 25.2%

We can also see here another business segment with very stable margins, showing no upwards or downwards trend.

Beauty: 18.4%

• Conditioners, Shampoos, Deodorants, Facial Moisturizers, etc.
• operating margin: 21.7%

For the Beauty segment is clear to see a downwards trend for its operating margin, probably caused by the loss of some competitive advantage and pricing power. This also results in this business segment being the one with the lowest operating margins.

Health Care: 14.3%

• Toothbrushes, Toothpastes, Gastrointestinal, Pain Relief, etc.
• operating margin: 25.4%

The Health Care segment shows the same operating margin stability of most of the other business segments, nothing really to pinpoint here as well.

Grooming: 7.9%

• Appliances, Male/Female Blade & Razors, Pre- and Post-Shave Products, etc.
• operating margin: 28.4%

Grooming is the business segment with the highest operating margin. Given the fact that this has also the lowest share of the company revenues, this could mean a great opportunity if Procter & Gamble can be more exposed to it in the next couple of years, increasing its overall operating margins.

The graph below also shows the company’s overall operating margin over time:

The operating margin has been very stable over the last couple of years. Nothing really surprising here given the stability we’ve saw on each of the business operating segments.

We can also graph the contribution of each business segment above described to the company total revenues over time:

The company is also very stable in its revenue exposure to the different business segments. Its not clear to me a future or present path for expansion or contraction for each segment, it all seems to be very cleanly maintained over time.

From what we’ve seen I can also go a step further and extrapolate that a possible reduction of its exposure to the Beauty segment (with a decreasing operating margin) and an increase of exposure to the Grooming business segment (with an increasing operating margin) would be a logic step in improving the overall operating margins for the company. However, from what is presented in front of us, this don’t seem to be the current or projected situation.

💡My assumption is that the operating margins will remain very stable around the ~23% mark and graudally the fierce competition of the company’s industry will bring it down to ~21%.

Sales / Capital ratio (Reinvestment)

This ratio (Revenues / [Total Equity + Total Debt – Cash] ) shows you how the capital invested in the business is being translated into its sales/revenues. Please remember that sometimes the company may invest today to only reap the benefits and sales after a couple of years.

Below you can see the last 5 years of Sales to Capital ratio for Procter & Gamble:

As well, here we can see that the company is maintaining its reinvestment levels.

💡I don’t see how this ratio could differ in the future from its historical levels. I will assume this will be maintained around ~1.11.

ROIC

Still related with the company’s reivestments, but this time with their return on the capital invested.

This ratio has also been stable over the last couple of years:

💡My assumption is that the company will still be able to return a little above its cost of capital long-term. I will have it converge to a ROIC of ~10% (above its estimated cost of capital) to a maximum of 15%.

Discounted Cash Flows (Weight: 50%)

I’ve used the latest annual report and my assumptions explained above to complete my Discounted Cash Flow valuation:

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of the US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Initial and Terminal Tax Rate – Given the fact that its historical averages are around ~21% I’m assuming the same value for both.

All the other inputs were taken from the financial statement or from my assumptions.

The DCF gives us an estimated fair value of 88.01 dollars for Procter & Gamble.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used my assumptions and the range explained on during those sections.

As you can see from the above Procter & Gamble seems to be overvalued given that its current price of 145 dollars is above P90. From these simulations we can extrapolate that there’s more than ~90% probability of Procter & Gamble being overvalued.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 30%)

For the EPS valuation, I designed three different scenarios, to be used later on the Monte Carlo simulation: a bad, a base and a good scenario. Everything about them is explained below.

Please note that the last EPS for the company is $6.90.

Also some relevant historical notes about the company:

Revenue Growth (CAGR)

💡 This was discussed earlier, but it is expected for the company to grow its revenues below the economy growth rate, so around ~3%.

Shares Outstanding (CAGR)

💡 Procter & Gamble has been buying back shares, I believe this will be maintained even if with the rate reduced a little bit.

Net Profit Margin (Average)

💡 As we discussed previously during the operating margin sections above, I expect this to be very stable even if tapering a little bit down to allow for some margin compression and pricing power loss.

P/E ratio (Average)

💡 I expect this to also remain around the same historical values or maybe decreasing a little bit from its upper range.

Knowing this, these were my three scenarios for the next 5 years:

Bad Scenario

• Revenue Growth (CAGR): 1.00%
• Net Profit Margin (Average): 16.00%
• Shares Outstanding (CAGR): -0.40%
• P/E ratio: 22
• EPS 5th Year: $6.42
• EPS CAGR: -1.43%

Base Scenario

• Revenue Growth (CAGR): 3.00%
• Net Profit Margin (Average): 17.50%
• Shares Outstanding (CAGR): -0.60%
• P/E ratio: 24
• EPS 5th Year: $7.83
• EPS CAGR: 2.56%

Good Scenario

• Revenue Growth (CAGR): 6.00%
• Net Profit Margin (Average): 19.00%
• Shares Outstanding (CAGR): -1.00%
• P/E ratio: 26
• EPS 5th Year: $10.01
• EPS CAGR: 7.73%

Given these assumptions and based on the historical data, I filled in and valued the company using the EPS Growth projections, discounted by the estimated cost of capital previously calculated and using the assumptions of the base scenario.

Then again, I used the Monte Carlo simulations to explore the possibilities on the lower (bad scenario) and on the higher (good scenario) end.

From this valuation, Procter & Gamble looks overvalued given that its current price of 145 dollars is between P80 and P90. We can extrapolate that there’s ~85% probability of the company being overvalued given this valuation method.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

EPS Scenario Returns

We can also explore a little further the different scenarios by projecting in time the bad, the base and the good case scenarios.

Feel free to try this yourself: EPS Scenario Returns — The Fair Value Journal

Dividend Discount Model – Stable (Weight: 20%)

Given the fact that Procter & Gamble pays around ~60% of its free cash flow as dividends to its shareholders, we will also use a Dividend Discount Model (DDM) to value the company.

In this method we will project in time the dividend payments and then discounting them back by the company estimated cost of capital. Also, because the historical dividend growth is around the economy growth rate we will use a stable model, assuming the dividends will grow at the same rate forever.

Dividend Growth

Procter & Gamble has been steadily increasing its dividends and below is shown the rate of that growth over the last couple of years:

💡My assumption for the dividend growth is that it would remain stable around the economy growth rate ~4.69%.

Note that I’m using the 10 Year U.S. bonds as a proxy for the economy growth rate.

Given this assumption and the fact that Procter & Gamble has a Cost of Equity of 8.74% we can calculate its fair value using a DDM valuation method:

Now we can also explore the lower and upper end scenarios for each input by using the Monte Carlo simulations:

Using this valuation method we can extrapolate that Procter & Gamble is overvalued given that its current price of 145 dollars is above P90. From this we can say that there’s more than ~90% probability of Procter & Gamble being overvalued.

✍️Summary

Now that we did all the heavy work, let’s take all of the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I would start adding again or initiating a position in Procter & Gamble below the 97.62 dollars mark, because this is indeed a great company and as we’ve seen all across this (long) post, a very stable one.

Please, as always, remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

Overall it seems Procter & Gamble is overvalued at its current market price.

Fair Value: 107.47 dollars.