September 28, 2009

Analysis - PG (US) II

Correction : I posted analysis of JNJ from an old file instead of P&G. correcting it now.

I started the analysis of P&G (US) in my previous post. The balance of the analysis follows

Competitive analysis
The company faces a host of competitors ranging from local to store brands to companies like unilever. Most of the local and store brands compete on price.

P&G has rightfully realized the need for innovating in all the categories to stay ahead of the competition and thus maintain a price premium. In addition the company has a wide portfolio of brands and an extensive marketing and distribution infrastructure. These competitive strengths allows the company to fight price based competition.

The company has been investing almost 10% in marketing and sales and 3% in R&D. These investments are key to maintaining the competitive edge of the company.

Management quality checklist
- Management compensation: The chairman received a total compensation and bonus of around 57 Mn usd, which does not appear excessive. The company has an options program which would result in a rough dilution of around 10% or less.
- Capital allocation record: The management has a very good capital allocation record. They have maintained an ROE in excess of 20% for the 7-8 yrs. In addition the company has maintained a dividend payout in excess of 40%. The excess cash has been utilized to fund acquisitions and buyback stock. I would give the management high grade on capital allocation.
- Shareholder communication: The company has communicated its strategy and focus on innovation. In addition the company has is also transparent in communicating the long term goals such as organic growth, free cash flow target etc and the achievement against the goals. The company has also discussed in detail the performance of each division with clear details of the organic volume growth to enable the investor to understand the source of the topline growth. The company has been consistent in communicating good as well as bad performance.
- Accounting practice: appears conservative and I could not find any red flags. The company seems to have made conservative pension assumptions, has minimal derivative exposures and other off balance sheet liabilities. My only concern is the benefit assumptions. Although the actual returns are negative, the company is using positive expected returns on assets (allowed by GAAP). If the returns do not turn positive, we could see higher pension expense in the future.

Valuation
The company has a free cash flow which is almost equal to net profits. The company has an ROE in excess of 20% and an average growth in excess of 8%. If we assume a CAP period of around 10 years, a net profit growth of 8%, the intrinsic value comes to around 72-75 usd per share. If one reverse engineers the current price, the implied growth seems to be around 2-3% for the next 10 years.
The company thus appears to be undervalued by around 20-25% at current prices.

Conclusion
The company has been able to show a low single digit growth inspite of the global recession. The topline however has shown a low single digit drop. The company is in the process of disposing non core businesses such as coffee and the medical division. This should provide the company extra capital to invest in the core business, retire debt or continue with the buyback program.
The company has maintained its focus on innovation and new products and has been investing heavily in brand building and R&D, even through the recession. This should help the company when growth returns. The company has enormous competitive advantages in the form of strong brands, deep distribution network and a innovation oriented culture. Although the company is not undervalued by a wide margin, it should give moderate returns in excess of the index returns over the next few years. In summary it is moderate return, low risk opportunity.

I have created a pdf version of the analysis. Please feel free to download and share with others.

8 comments:

Anonymous said...

are you talking about PG or JNJ?

Rohit Chauhan said...

sorry about the mixup. fixing the post now
rgds
rohit

Vic said...

Thanks Rohit. I like ur conclusion..especially: "In summary it is moderate return, low risk opportunity.:-) Similar to Infosys.

One question: Did you run your usual filters on both: P&G and J&J?
Do you use the same filters for US companies or diff from Indian comp. analysis?

Thanks,

Vikas

Rohit Chauhan said...

Hi vikas
lucklily in hindsight infosys for the time being has turned out to be a high return opportunity

i have similar filters and process for analysing indian and us companies. same goes for P&G or JNJ with obvious differences in the nature of industry and biz model

rgds
rohit

Anwar said...

The last two companies that you analyzed are J&J and P&G. Makes very interesting reading. But they are listed in the US so investing in them is a hassle.

While reading, I was thinking about a similar company available in India, Hindustand Unilever, HUL. It has a similar characteristics as J&J, P&G. Strong Pedigree, Great brands(Numbering 110), Good fresh cash flow, high and consistent dividend payouts and track record of serving and knowing the consumer in India for over 75 years. Have a look !!!

http://www.hul.co.in/investor/Financial_Trends/Financial_performance_10_years2008_09.pdf

It has terrific financial ratios. The ROCE and RONW have been consistently improving and now stand over 100%. The ROE is above 30% and EVA stands at Rs.2000 crores. In the universe of Nifty stocks, its OPM is lower than ITC, Infy and TCS though.

It was a darling of investors until the beginning of this century and has always quoted P/E of above 50.

But now,somehow, it seems to have fallen out of favour with the market and it is interesting to note that it is now quoting at almost at the same price as it was 10 years back. Even though, earnings have doubled and dividend payout has increased by more than 50%.

Typical Graham/Buffet stock with predictable business and strong free cash flow, currently out of favour? What do you say?

Anwar said...

The last two companies that you analyzed are J&J and P&G. Makes very interesting reading. But they are listed in the US so investing in them is a hassle.

While reading, I was thinking about a similar company available in India, Hindustand Unilever, HUL. It has a similar characteristics as J&J, P&G. Strong Pedigree, Great brands(Numbering 110), Good fresh cash flow, high and consistent dividend payouts and track record of serving and knowing the consumer in India for over 75 years. Have a look !!!

http://www.hul.co.in/investor/Financial_Trends/Financial_performance_10_years2008_09.pdf

It has terrific financial ratios. The ROCE and RONW have been consistently improving and now stand over 100%. The ROE is above 30% and EVA stands at Rs.2000 crores. In the universe of Nifty stocks, its OPM is lower than ITC, Infy and TCS though.

It was a darling of investors until the beginning of this century and has always quoted P/E of above 50.

But now,somehow, it seems to have fallen out of favour with the market and it is interesting to note that it is now quoting at almost at the same price as it was 10 years back. Even though, earnings have doubled and dividend payout has increased by more than 50%.

Typical Graham/Buffet stock with predictable business and strong free cash flow, currently out of favour? What do you say?

Rohit Chauhan said...

Hi anwar
I have looked at HUL in the past ..around 2003-2004 is when i looked at. i have worked in the FMCG industry (not HUL) and have seen at close hand the strenght of the companies brands, its distribution network and the high quality of its line managers. all this is reflected in the financials too.

the only reason for my skipping the company in the past was valuations. HUL atleast in 2003-2004 seemed overpriced. the implied growth in the price was higher than the growth that the company was delivering.

i need to check the company again to see if the valuations have corrected

rgds
rohit

Madhav Shivpuri said...

Hi Rohit,

I will be interested to see how you value/ analyze HUL as I beleive it is a long term play like P&G. However, I am not able to analyze it well as I get lost in the intrinsic value calculation process.

Madhav