Procter & Gamble Still Doesn’t Look Like A Safe Place To Hide
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- As a defensive stock, PG a stereotypical name to own during a recession
- But inflation and strong dollar creating significant risk to earnings
- At 22x this year’s earnings guidance, and 25x free cash flow, PG stock doesn’t look cheap enough to own yet
Six months ago, I wrote that Procter & Gamble (NYSE:PG) was not a safe place to hide in a bear market. PG stock has declined 20% since then. Yet, even now, the point still holds.
Even with a lower price, PG stock is far from cheap. Meanwhile, the risks that were building in April have only intensified, as evidenced in P&G’s fiscal first quarter report and full-year guidance on Wednesday morning. Long term, the stock should do reasonably well, but near term, it looks far from compelling.
P&G Weekly Chart.
A ‘Relatively Good’ Quarter
First-quarter results from Procter & Gamble were soft. Revenue increased just 1% year-over-year. Diluted earnings per share fell 2%.
Those results, however, were no surprise. P&G actually beat Wall Street estimates on both lines, if modestly so. The two big headwinds to Q1 performance are widely known: the strong U.S. dollar and the impact of broad-based, worldwide, inflation.
On a constant-currency basis, Procter & Gamble actually grew sales 7%. Earnings per share rose by about the same level.
In the context of an inflationary environment, that performance seems reasonably strong. To some extent, inflation did help results: pricing boosted revenue by nine percentage points in the quarter. Unit volume actually declined 3% year-over-year, though about two points of that pressure came from the end of sales to the Russian market.
But for a branded, often higher-priced, producer like P&G, a modest unit decline in this environment doesn’t look that bad. The company’s ability to take pricing and keep operating profit margins mostly intact shows both solid execution and the inherent value of P&G products.
So, while headline results aren’t terribly impressive, the market’s reaction — PG stock gained almost 1% in a red market — makes some sense. As a Goldman Sachs analyst aptly put it, the Q1 report was «relatively good.»
Is It Going To Get Worse For P&G?
The concern, however, is that what P&G is facing is not a single-quarter problem. The strong dollar shows no sign of abating. The company will start to lap these easier comparisons in fiscal 2024, but even a stable dollar at these levels provides a challenge. Rivals outside the U.S. that earn revenue and profits in local currencies gain a competitive advantage unless P&G chooses to lower dollar pricing and sacrifice margins.
More importantly, the fact that customers did little trading down in Q1 hardly means they won’t do so going forward. In the U.S. market — 45% of revenue in FY22 — the consumer remains strong. For the time being, low unemployment and solid household balance sheets mean consumers don’t to trade down — yet. If the feared recession arrives, that will change.
As is, P&G sees the tough environment continuing for the year. The company is forecasting revenue to decline for the year, including currency effects. EPS is expected to be about flat. Given share buybacks, that implies a decline in the company’s total net income.
It’s certainly fair to wonder if that guidance remains too aggressive. P&G modestly reduced its post-Q4 outlook because of rising inflation and currency effects. It would hardly be surprising if the company had to do so again at some point over the next three quarters.
PG Stock Doesn’t Look Cheap Enough
Yet, with those challenges, and even down more than 20% from the highs, shares hardly look inexpensive. Based on guidance, PG trades at about 22x this year’s earnings and roughly 25x free cash flow.
That’s actually toward the higher end of the stock’s valuation range over the past two decades. And given risks, an earnings yield of 4.4% hardly seems that compelling when the 2-year U.S. Treasury bond is yielding roughly the same.
Taking the long view, Procter & Gamble likely can support the multiple. Even accounting for currency, and barring a worldwide recession, the company should return to growth in fiscal 2024. The company has improved its products and its execution substantially over the past decade, and seems to have taken a clear lead over rivals like Unilever (NYSE:UL) and Kimberly-Clark (NYSE:KMB).
The long-term bull case for PG is that the short-term challenges will pass, but the attractive business will remain. There’s probably some truth to that. But those challenges are real — and can get worse. At this valuation, that in turn means that patience is advised.
