P&G Looks Expensive

The sustained acceleration in wide-moat Procter & Gamble’s PG top line throughout fiscal 2019 is a testament to the merits of its strategic agenda to rightsize its brand mix and drive productivity savings to fuel further investments behind consumer-valued innovation. The fruits of these efforts were again evident in its outsize organic sales growth (a whopping 7% in the fourth quarter, above the 4%-5% in each of the previous three quarters) that reflected a balanced contribution from higher prices, increased volumes, and favorable mix, each amounting to a 2%-3% benefit to sales in the quarter.

However, we don’t think the firm is aiming to reignite its sales trajectory at any cost; rather, we believe management is squarely focused on generating profitable growth longer term. As a part of these efforts, P&G aims to extract another $10 billion in costs, with an eye toward reducing overhead, lowering material costs, and increasing manufacturing and marketing productivity. In the quarter, this initiative contributed to a 120-basis-point improvement in underlying gross margins to 48.8%, although these efficiencies were partially offset by higher input costs, unfavorable mix, and unfavorable foreign exchange.

While we will likely bump up our $98 fair value estimate by a low- to mid-single-digit percentage to reflect the firm’s full-year performance and the time value of money, we view the shares as frothy at current levels (especially after the mid-single-digit advance following results), trading at a 15%-20% premium to our valuation. Despite the prudence of its course, we think the combination of much tougher comparisons (relative to the muted top-line increases it was lapping this year, including just a 1% bump in the year-ago fourth quarter) and persistent competitive headwinds (including the potential for increased promotional activity) may knock some of the shine off of P&G’s momentum.

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