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I presented my bullish view on Procter & Gamble (NYSE:PG) in my initiation report published in December 2023, indicating both price and volume growth may revert to historical trends. They released their Q3 FY24 result on April 19th with 3% organic revenue growth and 11% core EPS growth and raised the full-year EPS guidance. I am confident about their volume recovery in the near future as the inflation starts to moderate. I reiterate 'Buy' rating with a fair value of $175 per share.
Recent Result and FY25 Outlook
They delivered 3% organic revenue growth and 11% core EPS growth, driven by 0% growth in volumes and 3% growth in price/mix. My biggest takeaway for the quarter is the moderation of cost pressure stemming from input costs, logistic and labors, and the company is on the right track for volume recovery.
Procter & Gamble Quarterly Results
As depicted in the chart below, the company experienced flattened volume growth in Q3 FY24, a consistent improvement from the dip in Q2 FY23. The contrasting trajectory of price and volume indicates that Procter & Gamble has been seeking a balanced growth between volume and price/mix, in my view.
Procter & Gamble Quarterly Results
As indicated in my initiation report, I foresee Procter & Gamble will move towards a more balanced growth between volume and price/mix. For FY24, the company guides 4%-5% organic revenue growth with 1%-2% negative impact from FX. They estimate the core EPS growth to be around 10%-11% for FY24.
Procter & Gamble Investor Presentation
Here is how I think about their FY24's growth.
The Greater China represents 9% of total revenue, experiencing a 10% decline in Q3 FY24. The downturn was primarily led by the weak consumption sentiment in China, as well as a 30% revenue drop in their SK-II cosmetic products. The sluggish growth in the cosmetic market in China appears to be a widespread trend, and not limited to Procter & Gamble alone, in my view. Estee Lauder (EL) released their Q2 FY24 result on February 5th and their APAC business dropped by 7% year-over-year, primarily led by weak China growth. During the earnings call, Estee Lauder's management indicated the challenges posed by discounting and heavy promotional activities in the Chinese market. While I remain optimistic about the long-term growth potential in China, I don't anticipate a significant improvement in China in FY24.
CEIC's report shows that China consumer confident dropped by 2.3% in January, followed by another 5.6% drop in February 2024. The weakened consumer sentiment is caused by the bearish stock market conditions, and falling property prices in China, in my opinion.
CEIC Report
Based on the performance over the past three quarters, it appears more probable that Procter & Gamble can deliver 4%-5% organic revenue growth in FY24. Looking ahead to FY25, I believe that Procter & Gamble will achieve a balanced growth between volume and price, as I indicated in my initiation report.
The commodity price has started to fall in 2023 as illustrated in the chart below. As such, Procter & Gamble is going to encounter reduced cost pressures from input costs. During the earnings call, their management estimated that the company is going to have around $900 million tailwinds after tax in FY24 due to the decline in commodity prices. I believe they will likely continue to benefit from the falling commodity price in FY25.
FRED Statistics: Global Commodity Price
With less pressure from input costs, Procter & Gamble is more likely to adjust their overall pricing lower to stimulate volumes. I estimate their price growth will align with the overall CPI growth; as such, I estimate they can achieve 3% price/mix growth and 2% volume growth in FY25.
Valuation Update
As discussed, I assume 2%-3% pricing growth and 2%-3% volume growth, a more balanced growth trajectory in the future as the inflation begins to moderate. The company plans to pay out $9 billion in dividend and repurchase $5-$6 billion of own shares in FY24, totaling $14-$15 billion in shareholder returns. As such, I estimate the total number of shares outstanding will decrease by 2% in the near future.
The model assumes that Procter & Gamble will allocate 2% of revenue towards acquisitions, contributing an additional 1% of growth to the overall topline.
On the margin side, the main moving pieces are:
-Procter & Gamble is poised to potentially benefit from falling commodity prices in FY25, based on the recent trends of commodity price.
-As the cosmetic business in China carries a higher margin, the weakness in China would cause some headwinds for the overall operating margin.
- Procter & Gamble has been managing their SG&A spending over the past few years. The SG&A as a percentage of total revenue dropped from 27.6% in FY21 to 25.7% in FY23. I anticipate their cost optimization initiatives will continue in the near future, resulting in 15bps margin leverage from SG&A.
As such, I assume 15bps margin expansion from gross profit and 15bps from SG&A leverage.
Procter & Gamble DCF - Author's Calculations
The WACC is calculated to be 7.21% assuming:
-Risk free rate: 4.25% (US 10Y Treasury Yield)
-Beta: 0.6 (SA)
-equity risk premium: 7%; cost of debt 7%
-Tax rate: 21%
-Debt: $34.6 billion. Equity $46.7 billion
The terminal growth rate is assumed to be 4%, slightly higher than the global GDP growth rate. Discounting all the free cash flow, the fair value is estimated to be $175 per share. The current stock price is trading at around 23x of fwd. free cash flow. I view Procter & Gamble as a high-quality and stable company with MSD organic revenue growth and double-digit EPS growth; therefore, I believe that a 23x multiple of FCF is not expensive.
Key Risks
Foreign Exchange: The strength of the USD is expected to have a negative impact on Procter & Gamble's reported revenue and operating margin. In FY24, they have already indicated FX will cause further damage in the second half of FY24, especially in the upcoming quarter. Procter & Gamble has some business exposure in Argentina, where the Argentina peso has depreciated significantly against the USD in the past.
Destocking in US: Procter & Gamble has encountered some destocking activities in the U.S. market across certain product categories such as hair care and personal healthcare products, as communicated over the earnings call. The destocking activities may present some growth headwinds for the company in the near-term.
Conclusion
I maintain Procter & Gamble in my portfolio as a defensive stock, reducing the overall volatility of my portfolio. I believe Procter & Gamble will transition towards a more balanced price and volume growth in the near future. The falling commodity price could benefit their margin expansion in the near future. Their current stock price is still attractive, and I reiterate 'Buy' rating with a fair value of $175 per share.
