Procter Gamble

Stock price:$59.8
Conclusion: P&G looks in good shape in tough conditions. Market share is up, combined with improved margin. We reconfirm our valuation target of $73-$75 per share.

FY10 results: Sales up 3% (+4% organic) to $78.9bn (+4% Q4)-EBIT +4% (20.3% margin)-Core EPS $3.67 up +6%. Guidance F11: net sales (+4-6% organic) EPS expected to be in the range of $3.91-$4.01 up +7-9%.

Value share up 50bp
Sales growth reached +4% (organic) both for the full year and Q4.
-Growth increasingly driven by volume. Volume growth reached +4% for the year and doubled to +8% in the fourth quarter. Volume in emerging markets are booming (+12%) which was expected. The good news comes from volume in mature markets which increased 5% at a time when most competitors are struggling with lower sales (cf Unilever in Western Europe)
-Value growth held back by lower mix (-1% FY -3% Q4) and to a lesser extent pricing (-1%). Faster growth in emerging markets combined with trading down led to sharply negative mix impact.
- Organic growth accelerated in key categories in Q4, notably beauty or grooming. Fabric care and Home care is the exception with flat sales resulting from a very agressive pricing strategy.

Underlying gain in margin looks strong.
Operating margin was up 30bp for the year, despite the negative impact of higher advertising charges (+120bp).
-Gross margin rose 250bp (+50bp in Q4) providing room for manoeuvre. Costs savings in Q4 (+200bp) added to volume leverage (+100bp) more than offset negative price/mix (-200bp) and higher commodity costs (-50bp).
-We welcome the return to higher advertising spending ($1bn more in F10) in order to support a strong innovation pipeline. SG&A rose sharply in Q4, heavily impacted by marketing expenses, mainly responsible for the decline in profitability. We share management’s view that the profitability should be reviewed on a yearly basis and don’t think one should overplay quaterly variations.

Guidance F11: too high ?
Guidance of +7 to +9% EPS growth might look ambitious in light of the negative impact expected from forex and commodities this year.
-We think top line could slightly exceed F10 performance for two reasons: first, volume will be fueled by the innovations which took place late last year (new Pantene, Fusion Pro Glide..) plus the roll out of brands in new markets in oral care and skin care. Second, pricing could turn neutral for the full year (still negative in H1) as Procter will start annualizing some price decreases (batteries, detergents or paper towel in the US). Mix should continue to hold back sales impacted by further trading down.
-Gross margin could further improve helped by savings from productivity and simplification initiatives ($400m to be invested in F11) while advertising spending could remain stable as a percentage to sales.
-EPS growth will be enhanced (+2-3%) by share buy back estimated between $6-$8bn this year.
We look for $81.7bn sales-$17bn EBIT-core EPS of $3.92 per share (+6.8%).

P&G trades at 15.8xPE based on our calendar estimates, well below its 17x average. We think that accelerating top line and bridging the gap with peers such as best in class Reckitt should help to rerate the stock. Our DCF suggests a valuation closer to $75 per share.

Procter Gamble

Stock price: $62.1
Conclusion: Gaining share despite negative impact from pricing and mix. We reconfirm our valuation range of $73-$75 per share in light of Q3 results.

Q3 results: Sales up 7% to $19.2bn (+4% organic). EBIT margin up 80bp. Core EPS up 10% to $0.89. FY guidance: net sales growth +3+5%. Core EPS increased to $3.62-$3.68 (vs $3.53-$3.63), up 4-6% versus last year.

Procter gaining share in home and fabric care and grooming.
-Sales grew 4% (+3% 9m) versus +2.5% for the market driven by high single digit growth in developing countries and only 1% growth in Europe and in the US.
-P&G outperformed Unilever and increased sales in line with Reckitt in fabric and home care (+5%).
-Share rose by +0.5pt in baby care (+7%) and slightly less than +0.5pt in blade and razors (+4%).
-The bad news came from beauty up only 2% at a time when competitors are showing accelerating growth. We look for accelerated momentum in Q4 and beyond. First, most of the growth rate differential stems from a weaker base period: L’Oreal sales for instance declined by 4.3% in Q1 last year, while P&G maintained sales flat. Second, management indicated that it is currently restructuring its hair salon portfolio. Nevertheless, we think that L’Oreal is fundamentally better positionned in the professional salon business thanks to its vertical integration in the US. Third, sales in Q3 were impacted by destocking in preparation for the relaunch of Pantene. Last, the flagrance business should be boosted by the launch of a new perfume: Gucci for Men.

Bottom line driven by productivity gains and costs savings.
-Gross margin improved 290bp in Q3 (+310bp 9m). The bulk of the improvement came from manufacturing and costs savings (+190bp) which bodes well for fiscal 2011. Management confirmed that it is working on a very strong cost savings program which should lead to further gains next year. Commodity and energy costs also played a role, but their impact was lower at +90bp. Going forward, gross margin is expected to be impacted by a negative swing in raw materials costs.
-Growth margin next year will also depend on pricing and mix which were negative by 1% and 2% respectively in Q3. We think pricing could stabilize influenced by a more adverse input cost environment. Mix will continue to be impacted by faster growth in developing markets, but could be partly restored by superior growth in prestige sales and improved traffic in the salon business.
-Marketing expenses were up leading to higher SG&A (+210bp in Q3 vs +120bp 9m). Management made it clear that a multi year innovation program requires continuing marketing support. As a result, we expect spending to remain stable as a percentage of sales next year.
-EBIT margin could reach 21.2% in FY2010, up 80bp vs last year. We look for 20bp gain next year to 21.4% and +8.5% EPS growth.

Procter Gamble trades at 16.2xP/E based on calendar 2010 estimates, implying 20% discount to its cosmetics peers in Europe. Our DCF suggests a valuation closer to $75 per share.

Long PG at time of writing.

Procter Gamble

Stock price: $61,7
Conclusion: Q2 numbers show that Procter&Gamble starts to reap the fruits of its marketing initiatives. Top line growth is accelerating driven by volumes while positive leverage more than offset higher A&P spending. We expect investors to welcome this virtuous circle. Procter trades at discount to the sector which makes it attractive. We look for 20%+ return for the next 12 months based on our valuation range of $73-$75 per share.

Q2 results: Sales up 6% to $21bn, up 5% like for like. Core EPS up 22% to $1.10. Guidance for 2010 raised from $3.47-$3.59 to $3.53-$3.63 (+2% to +5%)

Procter reported a strong acceleration in growth from +2% in Q1 to +5% organic in Q2, driven by a bounce back in volumes up 5% (vs -3% in +Q1). Baby care, fabric and home care and beauty posted strong gains, driven by innovation. Pricing remained positive (+1%) despite some adjustments, notably in laundry, tissue towel or batteries. Mix was down 2% as a result of faster growth in emerging markets. According to management, 3% growth came from the market and +2% from inventory building vs last year, resulting in flat shares.
Going forward, we think that Procter Gamble could reach the high end of its +3+5% sales growth target for F10 due to:
-accelerating market growth (+2+3%)
-sequential improvement in the salon and the prestige businesses in H2 (according to Estee Lauder, prestige sales outpaced mass sales in the last two months of 2009)
-higher marketing spending and innovation rate
-compensating for lower pricing and a slight negative impact from Venezuela.

The second quarter and H1 underline the good balance between rising gross margin and higher marketing spending, leading to a 160bp gain in operating margin.
Gross margin rose 330bp in Q2 (+310bp H1) thanks to lower commodity costs, manufacturing savings and pricing.
Simultaneously, SG&A increased 170bp in Q2 (+150bp H1), due to higher marketing spending. Progress in H2 will be held back by less pricing, lower commodity tailwind and the negative impact of Venezuela. Notwithstanding more headwind in H2, we expect Procter&Gamble to achieve 20.9% EBIT margin for the full year against 20.4% reported last year.We think that Procter&Gamble could achieve the top end of its $3.53-$3.63 per share forecast.

Procter&Gamble trades at 16xP/E based on calendar 2010 estimates, implying a 20% discount to its peers in Europe. Our DCF suggests a valuation closer to $75 per share. We think that the stock offers 20% upside potential based on a valuation range of $73-$75 per share.

Long PG at time of writing.