Warren Buffett, the ‘Oracle of Omaha’, is probably the world’s greatest investor, but he doesn’t always get it right. I, for one, wouldn’t have loaded up on Goldman Sachs, General Electric or Wells Fargo recently due to the opaqueness of their balance sheets. Another of Buffett’s stars is Procter & Gamble.
Procter & Gamble (US:PG), rated as OUTPERFORM by Oppenheimer
Procter & Gamble is the world’s top fast-moving consumer goods company. Its huge stable of brands includes names such as Pampers, Ariel, Olay and Crest. The latest addition has been the ‘Fusion’ four-blade razor, after its $53bn acquisition of Gillette back in October 2005. With such a diverse portfolio, a huge geographical footprint and its leading franchises, Procter & Gamble is a classic defensive play and very attractive to institutions in times of crisis.
But here’s the rub. This well-trodden trade looks past its sell-by date; Procter & Gamble’s 20% operating profit (EBITA) margins are just too good to be true, especially with challenging headwinds. Aggressive supermarket chains such as Wal-Mart and Aldi are demanding bigger discounts, introducing their own cheaper varieties and even delisting products en masse. And here’s the really scary thing. With thousands more own-label products being introduced, branded goods will inevitably lose shelf space. If it isn’t stocked, then it can’t sell.
Cash-strapped consumers are cutting back, particularly in Procter & Gamble’s homeland, America. As a rule of thumb, brands can usually only sustain a price premium of up to 15% compared with own-label equivalents before they begin to lose market share. With supermarkets going hammer and tongs at each other, it doesn’t take a PhD to realise that prices and margins on branded products will suffer too. On top of all that, about 60% of Procter’s top-line growth is attributed to emerging markets (such as eastern Europe), some of which are running into serious trouble due to credit issues.
For 2009, the board expects organic growth of 2%-5% (implying it will miss its 4%-6% target), with underlying EPS of $4.20 to $4.35 per share. That puts the stock on a stretching ‘top of the cycle’ EV/EBITA multiple of 10.7 times (equivalent to 2.2 times sales), which looks far too steep. I would value the group on a ten-times EBITA multiple, assuming sustainable margins of 17%. After deducting $31bn of net debt, that delivers a fair value of roughly $34 per share, or 25% less than today. Procter is certainly a quality business, but it is exposed to belt-tightening by shoppers and cut-throat tactics by the big chains. Given the risks and the lofty valuation, I would advise shareholders to disembark.
Recommendation: SELL at $48.00
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments