P&G Continues to Clean Up in Q2; Valuation No Bargain

It wasn’t that long ago when wide-moat Procter & Gamble was dogged quarter-after-quarter for boasting lackluster revenue growth; however, with the company posting its eighth consecutive quarter and second consecutive year of mid-single-digit organic revenue growth, we don’t think these concerns are top of mind for investors at this juncture (with shares up more than 2% on the print). We attribute this staunch performance to its radical decision six years ago to materially prune its brand mix (cutting more than 100, leaving it with just 65) and focus its resources on its highest return opportunities as a means to more nimbly respond to evolving consumer trends.

But the firm hasn’t gone headfirst into boosting its sales trajectory. Rather, it has astutely balanced driving profitable top-line improvement. This was again evidenced in the fourth quarter, as adjusted gross and operating margins expanded 210 and 140 basis points, respectively, to 50.9% and 21.0%. And we don’t expect the firm will prioritize margin gains to the detriment of its leading brand mix and its entrenched retail relationships. As such, our forecast continues to call for P&G to expend 3% and 11% of sales to research and development and marketing, respectively, up from less than 3% and 10.5% on average the past few years.

Although uncertainty abounds (and is unlikely to wane over the near term), we think P&G maintains the wherewithal to withstand impending macro and competitive pressures. We will likely bump up our $109 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 but don’t expect to materially amend our longer-term outlook (nearly 4% average annual sales growth and a 200-basis-point bump in operating margins relative to fiscal 2020, to more than 24%, by fiscal 2029). However, shares fail to offer an attractive risk/reward opportunity at present, trading about 20% above our valuation.

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