From selling candle and soap, this small family business grew through innovation, strong marketing and partnerships to become one of the largest consumer goods company in the world. They created the world-famous tide washing pods and pampers, which I’m sure many of you might have used and even acquired Gillette. So, what’s changed throughout the years in the way we consume and require these necessities? Well, besides there being more people and therefore more consumers, nothing much.
As I did with my last valuation of Boeing, I split up the cashflows into two segments. The virus affected phase and the recovery. Predicting the effects of the pandemic by production is much harder for P&D than Boeing. Where Boeing has only 3 main segments and produce a few planes a month and give a choice of no more than 30 types of airplanes, it was much easier to forecast their performance. For P&G who sells basically everything that you’ll find in your bathroom, it is a little trickier. I sufficed and look at the FRED (Federal Reserve Economics Data) and there I analysed the PCE data (Personal consumption expenditures excluding food and energy). Since the goods P&G sells are basic necessities, they are less likely to be affected by the stock market and rather have the consumer choice as a key driver. In the current situation it is important to look at how much people are willing to go to shops and buy these goods. Now, naturally we expect this to be less as people don’t want to risk leaving their house to get infected, but since these goods are necessary for most of us, we will still be buying them. So, for the revenue growth for FY1 I used the PCE data for times when there was a recession. As a result, I predicted a near to flat growth in revenues in 2020. A similar story goes for the recovery where I used the PCE data for times when there was a recovery.
Form FY2 to the terminal growth, the revenue growth is slowed step by step. The terminal growth is very conservative based on the firm’s project commitments and their expected returns. This is used because the growth we expect for the section when P&D reaches steady mature growth will depend significantly on how much they’ve invested into the future and what return they are receiving from these investments.
The cost of capital is relative to other sectors is low. This is because we are dealing with products that are still being bought even if there is a recession and therefore the firm has a low levered (debt adjusted) beta (around 0.32). As I did with Boeing, I expect this value to tend towards the market median as the cost of receiving capital will be similar to everyone in the long run.
The Operating Margin has been improving year by year and so based on the market median I expect the value to be slightly higher at 25% since P&G is a leading producer of the products, and with the large quantities it outputs it can benefit massively form economies of scale.
Tying up loose ends
For this valuation I included a section for the adjustment of the value of equity. This is because throughout our model we accounted for several value added and value restricting factors. But it is important to tie up loose ends. One important factor is the equity issued to employees. In recent years, firms have turned to giving employees equity options and restricted stock packages as part of compensation. The options are usually long term and volatile on stocks. The restricted stocks are usually restrictions on trading. Dealing with restricted stock is pretty simple, you just find the stocks that have been granted in shares outstanding today. It is shown in the 10-K fillings in this case.
For options it’s a little harder. Options can affect equity in two ways. Shares are issued at below the market price. Then get exercised only when they are in the money. Alternatively, the company can use the cashflows that would have been available to equity investors to buy back shares which are then used to meet options exercise. The lower cash flows reduce equity value. Options also affect the equity before exercise because there’s an expectation that there is a probability of and a cost to exercise. We can use a model called Black Scholes that is adjusted to dilution to come up with a value.
Once we have these values the rest is pretty simple. We minus them from the Equity value. There are other possible adjustments that we could have made. Some firms have holdings in other firms for which the equity has to be adjusted. If you choose a firm like this, you are basically having to do multiple valuations inside of one another. Also, assets that are generating no cash flows have to also be valued. A good example would be Playboy, who owns the Playboy mansion, which is generating no cash flows. Other assets like this can include paintings, vacation land etc.
Finally, I calculated a probability of failure based on the pricing of the bonds P&G has outstanding. In the equity value adjustment, I assumed the worst-case scenario, where the bailout results in the equity going to zero. However, if your opinion differs, use the table below to make your decision.
We might expect that a firm that has changed so much throughout the years to continue growing at a tremendous rate, bringing in new consumers and taking over the world. However, we need to understand that the success here is not dependent on how amazing their products are but how much people need them. We needed to brush our teeth, wash our hair and clothes 200 years ago and just as much, we need to do the same now. Not much has changed since then, only there is more of us now. So, the success of this company will naturally be dependent on outpacing their competitors, having shiny, strong brand marketing and coming up with new products to shave your face (or legs) but mainly it’ll simply be down to how fast the world population will keep growing.
All opinions in this post are for non-professional investing and is solely my opinion. The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance. Only invest money that you are willing to lose.