P&G: Ready, Steady, and a Little Go

The consumer-products giant has rebounded strongly. Now, some analysts see the stock as a bit too pricey for its slow-growth prospects

By Amy Tsao

The past couple of years have been rewarding for Procter & Gamble (PG ), whose $40 billion in annual sales make it the largest U.S. consumer-products company. Increased marketing of its biggest brands, like Tide detergent and Bounty paper towels, and innovations, like Crest whitening strips, helped reverse earnings shortfalls in the spring and summer 2000 that had sent the stock tumbling to a multiyear low.

The shares have rebounded 70% since June, 2000, when A.G. Lafley was appointed CEO of the Cincinnati-based outfit. Under his leadership, results have improved dramatically. In fiscal 2003, analysts project that P&G's earnings per share (EPS) will rise 32% over the previous year. That would come atop a 49% jump in EPS in fiscal 2002. The big question: At $90 as of May 19, just a few dollars shy of its 52-week high, how much room does P&G have left to run?

In the short term, a maker of consumer products trading at 20 times next fiscal year's earnings projections seems pricey -- perhaps even risky, especially as investors begin to favor high-growth stocks in what looks to be a recovering market. And the bulk of P&G's savings from its three-year-old turnaround strategy are already reflected in the current price, many investors fret.


  "When we want to move into some higher-growth-potential stocks, this is one we could definitely take a little out of," says James Luke, director of growth equity and portfolio manager at BB&T Asset Management in Raleigh, N.C. (Luke says BB&T bought shares in 2001 at around $73. He personally doesn't own any.)

Like most money managers, Luke says he wouldn't drop P&G entirely, seeing it as a steady, long-term name worth keeping in the mix. And it should remain a relatively solid holding for investors seeking safety in a difficult market, even though quite a few stocks in the consumer-staples sector -- food, beverage, tobacco, and health-related companies -- haven't been such stellar performers.

On May 14, Standard & Poor's cut its recommended weighting of consumer staples to "underweight." (Like BusinessWeek Online, S&P is a unit of The McGraw-Hill Companies. It doesn't do investment banking, and its analysts don't own shares in stocks they cover.) Even though S&P believes earnings are likely to stay on track, it downgraded the sector because the stocks of faster-growth companies are expected to gain momentum and look more attractive as the economy picks up steam.


  S&P is keeping its highest 5-STARS rating (strong buy) on P&G, however, anticipating that it can beat a conservative long-term sales target of 4% to 6% annual growth in fiscal 2003. It sees 7% sales growth, with help from a weakening U.S. dollar and volume growth resulting from intense focus on P&G's top brands. And EPS should rise in fiscal 2003, ending June 30, by 13%, says S&P.

Boosting market share with existing products and adding new lines are both key if P&G is to keep hitting its targets. In coming quarters, it's counting on continued strength in the health and beauty divisions for growth. Within the health-care unit, osteoporosis drug Actonel, with a market share of 21%, and new Crest dental-care products need to stay strong. P&G has said it expects Actonel to reach $1 billion in annual revenues.

Led by new products Whitestrips and SpinBrush, the Crest franchise is likely to grow healthily -- sales rose 30% in P&G's most recent quarter. Revenues also are rising -- in the high single-digits -- at its fabric and home-care division (which includes Tide and Dawn detergents) and in its baby- and family-care line (which includes Charmin toilet paper and Pampers diapers). By Amy Tsao


  The beauty division has soared from the purchase of Clairol from Bristol Myers Squibb (BMY ) in 2001. Profits jumped 19%, to $147 million, as sales rose 18%, to $1.4 billion in the fiscal third quarter ended Mar. 31.

Now, P&G is looking to buy Wella, the German hair-care outfit, for another boost. It picked up the majority of Wella's shares in March and is negotiating with a minority stockholder to take full control in a deal worth more than $6.4 billion in total. If approved, the Wella purchase would position P&G in professional outlets like salons, particularly in Europe and Latin America, and it would add 3.4 billion euros, or about $4 billion, to the top line.

P&G still looks to North America for more than half of its sales -- about 57% of $40.2 billion in fiscal 2002. Global markets are becoming more significant, however. In the fiscal third quarter, Prudential Securities analyst Constance Maneaty figures that volume growth in China rose more than 20%, vw. 10% in Western markets. Considering that Asia accounted for just 10% of sales last fiscal year, P&G should have plenty of opportunity to expand in that emerging market. (Maneaty doesn't own shares, and Prudential doesn't perform banking services.)


  On the downside, some P&G divisions are struggling. Its smallest and weakest unit, snacks and beverages (including Folgers coffee and Pringles potato chips), continues to stumble amid rival foodmakers' heavy promotional spending. Sales rose 1%, to $756 million, in the fiscal third quarter, but net earnings fell 22%, to $50 million. Many analysts expect that P&G may divest the division to focus on more promising businesses.

While P&G admits that the food business is tough, it also points to its success increasing Pringles' market share over the past two years. As spokeswoman Jeannie Tharrington, explains it, P&G plans to reduce its use of "less efficient promotional spending" to get earnings for snacks and beverages back on track.

All in all, P&G does have long-term growth potential, though probably at a slower pace than seen in recent years, says Jeff Graff, analyst at Columbus (Ohio)-based Victory Capital Management. "We will continue to see margin improvement, but the magnitude will decline over the next couple of years." (Victory Capital owns P&G shares.)


  Investors might want to consider P&G as a long-term portfolio holding, though perhaps at a lower valuation. "It's not a stock we would sell, but it's not at a point we would get in either," says Morningstar analyst Carl Sibilski. He recommends buying between $76 and $80 per share. P&G shares are still cheaper than its closest U.S. competitors, Colgate-Palmolive (CL ) and Gillette (G ), which respectively trade at 23 and 21 times 2004 earnings. (Sibilski doesn't own shares in P&G, and Morningstar doesn't perform banking services.)

With P&G appearing determined to maintain and build existing product lines and add new ones, Maneaty figures Wella's successful integration and a recent pact with Hewlett-Packard (HPQ ) to do most of P&G's data processing will help support earnings growth in 2005 and beyond. Her stock-price target is $110.

Maneaty's optimism may turn out to be warranted, given the successful makeover of the last two years. "The investment risk with P&G is high expectations," says Sibilski, who notes that the stock already has enjoyed a robust rebound. Still, in the eyes of many buy-and-hold investors, P&G looks like a strong contender.

Tsao covers financial markets for BusinessWeek Online in New York

Edited by Beth Belton

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