Procter & Gamble: Resilience In The Storm (NYSE:PG)

Procter & Gamble (PG) reported its third-quarter results in the midst of the COVID-19 crisis. The results are of course very interesting with the market trying to get a clue about the impact of the crisis on the business.

Of course, Procter has seen a one-time jump in sales driven by the hoarding effect, yet investors look for clues about the structural increase in demand as well, with consumption of food and related products shifting from leisure, hotels and restaurant towards retail, perhaps in somewhat a more structural way. This effect seems somewhat limited and shares already trade at pre-coronavirus levels, making me cautious despite solid operational performance.

The Third-Quarter Numbers

Procter & Gamble reported solid third-quarter results with sales up 5% to $17.2 billion. The quality of growth was good with volumes up 6%, pricing contributing a percent and currency headwinds shaving off two points from the reported growth rates. Growth marked a solid acceleration from the 3% increase in volumes reported in the second quarter.

Beauty and grooming categories reported flat to 1% increase in volumes which actually marks a deceleration from the growth reported in the second quarter. Health care, fabric & home care, and baby, feminine & family care all grew between 7% and 8% in terms of volumes.

CEO David Taylor specifically cited the strong role which the company plays in meeting daily health, hygiene and cleaning needs of consumers across the globe. The company points towards strong demand in Europa and North America, already resulting in roughly double-digit growth rates, in part offset by volume declines in Asia due to disruption there related to the COVID-19 pandemic.

The company managed to deliver on very modest operating leverage on the bottom line. Reported earnings were up 6% to $2.92 billion as a modest decline in the share count led to diluted earnings per share up 8% to $1.12 per share. Excluding currency effects, the so-called earnings per share were up 10% to $1.17 per share, although pretty much all the time the company faces currency headwinds.

Based on the fact that three quarters have already been reported and the outlook for the final quarter of the year is funnily enough quite strong, there is little risk to the near-term outlook for the company. Despite the current momentum, the company is maintaining the organic growth rate, with reported full-year sales now seen at 3-4%, down a point from the last updated guidance. This comes as the company is experiencing stronger currency headwinds following some recent dollar strength. Despite this development, the company furthermore maintained the guidance, both on reported and adjusted earnings.

Valuation Thoughts

With Procter maintaining the earnings guidance, the company still sees adjusted earnings between $4.88 and $5.02 per share, as I calculated late January with shares trading at $126 at the time. This reflected a full valuation at around 25 times earnings at the time.

Net debt of $21.9 billion at the time (excluding pension liabilities) resulted in a modest leverage ratio with EBITDA running at $17-$18 billion. While the earnings multiple was high at the time, it is the same now as shares trade just a dollar lower at $125, while the earnings guidance was unchanged.

Comforting is that net debt has been reduced to $20.6 billion following a solid cash flow generating quarter, leaving plenty of firepower for M&A activity and other capital allocation decisions, although a 25 times multiple does not look very compelling at a big premium earnings multiple.

Final Thoughts

Currently, shares trade at $125, similar levels at which shares traded ahead of the crisis, marking a significant outperformance versus the market. Shares have taken a breather as well and temporary fell below the $100 mark in March, as investors feared that the company was not as defensive as perhaps thought.

The company has seen a small bounce in earnings and sales this quarter, driven by some hoarding, yet the structural boost in demand seems quite modest, at least far more modest compared to pure food plays.

In January, I noted that at $125, the earnings yield was not compelling enough despite the solid performance, as this was largely a play on interest rates. Earnings yields are basically the same with interest rates having fallen further, and all of this created a real buying opportunity when shares fell towards $100 in March, yet massive and even larger opportunities were found at the time as well.

Despite a 6% increase in the dividend, which is in line with earnings growth and thereby results in flattish payout ratio, the yield of about 2.5% is not that high, but at the same time is far higher than the interest rate levels of course.

Of interest on the conference call is furthermore that the company recognizes we are already in recession, yet it believes that it has fewer discretionary products and more value brands compared to the recession a decade ago, as the improved positioning limits the impact of the current woes. Another interesting fact is the strong 35% e-commerce growth, now making up 10% of sales and that is quite a testament for the company.

While all of this is to be applauded and this is a defensive play with probably solid returns for long-term holders, I fail to see imminent appeal here, certainly in relation to the wider market. While the market has seen a significant bounce from the recent lows, it continues to underperform compared to a defensive play such as P&G.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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