P&G's Lofty Trajectory Won’t Always Persist

Procter & Gamble PG knocked the ball out of the park again to start its fiscal 2021, posting 9% organic sales growth (on top of 7% growth a year ago), 170 basis points of gross margin expansion to 52.7%, and 320 basis points of adjusted operating margin improvement to 27.3%. Although we acknowledge that a portion of this progress is attributable to consumers’ penchant for the leading home, health, and hygiene fare within its mix over the past few months (with sales in the U.S. up 16% in the quarter), we surmise that P&G had begun to steady its footing long before COVID-19 arrived. More specifically, we’ve held that the decision to ratchet down materially the size of its brand mix (to just 65, after shedding more than 100) was a critical step that has facilitated its ability to hone its resources on the highest return opportunities and more nimbly respond to evolving consumer trends.

With its solid start to the year, management opted to raise its fiscal 2021 sales (now calling for 3%-4% reported sales growth, up from 1%-3%) and profit expectations (5%-8% increase in adjusted EPS, from 3%-7%). As such, we intend to edge up our $111 fair value estimate by a low-single-digit percentage to reflect more pronounced sales prospects this year combined with a time value of money benefit. Even though we anticipate that a portion of these sales gains will prove sticky (as consumers have adopted a greater proclivity for home and personal cleaning), we don’t expect to alter our longer-term outlook (nearly 4% average annual sales growth and a 150-basis-point bump in operating margins relative to fiscal 2020, to more than 24%, by fiscal 2030) as we expect competitive pressures will eventually constrain its pace. And while shares ticked up by a low-single-digit percentage on the print, we don’t believe investors should rush to stock up on this wide-moat name, which trades at a more than 20% premium to our assessment of intrinsic value and a lofty mid-20s times forward earnings.

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