Procter & Gamble Stock: Retain ‘Buy’ Rating Despite Headwinds

In July 2022, we have published an article on Seeking Alpha titled: “Procter & Gamble appears to be an attractive option now”. In that article, we have rated Procter & Gamble’s (NYSE:PG) stock as “buy” and elaborated on the reasons why we believed that the stock could be an attractive opportunity. To briefly recap, our main arguments for the buy rating were:

• The firm and the stock have historically performed well during periods of low consumer confidence
• Strong financial performance in the first quarter of 2022
• Attractive quarterly dividend payments and a strong track record of dividend growth
• Continuous value creation for shareholder through share buyback programs

On the other hand, we have also highlighted several risks that could have a potential negative impact on the financial performance of the firm. These were: commodity and freight cost increases, geopolitical disruptions and the increasing competition in China, together with potential COVID related disruptions.

Today, we are revisiting our thesis and giving an updated view on the topics mentioned above. We will primarily focus on why we still believe that PG’s stock could be an attractive choice in today’s market environment.

The demand for PG’s products remains high

During the last three months there were several pieces of news and reports that have indicated that the demand for PG’s products is still healthy.

One indication was that Amazon’s (AMZN) Prime Day event, diapers and wipes from Pampers (a PG brand) were some of the best selling items.

This is in contradiction to what has been said by Evercore ISI analyst Robert Ottenstein, who stated that the economic reopening still drives the demand for household products, leading to depressed demand for diapers, tissue papers and detergents. On the other hand, due to pricing/mix, earnings are expected to recover in 2023.

Despite missing on the earnings estimates in FQ4, revenue growth was 3% year-over-year, reaching as much as $19.52 billion, beating the estimates by $110 million.

This miss led to a sharp drop in prices after the earnings release. The main driver of the miss on earnings estimates was the increase in commodity costs and freight costs, causing the gross margin to contract by as much as 450 basis points. These headwinds however, were partially offset by the 8% increase in pricing. The situation in China and Russia has also created further headwinds for the company.

In our previous article, we have already highlighted the risks related to the elevated commodity and freight costs, together with the potential problems in China. Therefore, the information shared during the conference call has not been entirely surprising for us. Further, the firm expects that in fiscal 2023, these headwinds are likely to remain and shape the macroeconomic landscape.

Further, P&G CEO has remained optimistic about the demand and the firm’s performance in the current environment:

[…] demand continues to be strong and the current U.S. economy has not dipped into a downturn, despite the recent GDP statistics showing a second consecutive quarter of declines. […] Based on the slice that we see, at least of the U.S. economy, things are very good. No recession, […]

For these reasons, we believe that our earlier arguments still hold true and therefore we do not see a reason for downgrading the stock at this moment.

Valuation

While we previously mentioned that PG is trading at a premium compared to the consumer staples sector median, after the earnings induced sell-off, the price multiples have slightly contracted, making the firm somewhat more attractive from a valuation perspective than in July.

Key takeaways

As expected, macroeconomic headwinds kept negatively impacting PG’s financial performance during the FQ4. Elevated commodity prices and freight costs have led to margin contractions, resulting in a worse than expected EPS in the quarter. The firm has managed to somewhat offset these headwinds by pricing, however could not fully do so. These risks we have already considered, when we issued out first buy rating on the firm in July.

There have been several contradictory opinions about the demand and the drivers of the demand for PG’s products. In our opinion, despite the price increases, demand is likely to remain high, and less impacted by the low consumer confidence than the demand for other, non-essential, discretionary products.

After the earnings induced sell-off, the company became also slightly more attractive from a valuation point of view.

As our previously outlined thesis is still largely intact, we believe that the “buy” rating is still appropriate for PG’s stock.