Procter and Gamble research report - Term Paper Example

?Table of content Table of content Procter and Gamble research report 2 Summary and investment recommendation 2 Business summary 3 Risks 4 Valuation 4 Dividend discount model 5 Free cash flow model 6 Residual income valuation 7 Value based on market multiple 7 Reference 9 Appendix 9 Procter and Gamble research report Summary and investment recommendation Procter and Gamble Company is a manufacturing company involved in production and distribution of consumer products. The company has since 2001 doubled its sales as a result of developing new market by acquiring and integrating Wella and Gillette and selling its coffee, pharmaceutical and food enterprises. The sales growth is expected to expand by 2%-4% in future. Also, the company has taken some major steps in divesting into noncore businesses, repositioning product portfolio in to more offering value, increasing spending to recapture and defend market share and expanding investments in overseas markets. The company management has responded to investors worry on costly structure and slow top line growth rate by through a cost saving plan worth $10 billion. This is expected to reduce the headcount that will enable the company achieve its earning per share growth rate forecast to 8% and 10% in free up funds that can be reinvested. Third quarter results shows that the organic sales have increased by 3% from its previous quarter but the operating profit decreased by 11%. The management of the company lowered the earning per share to $3.82-$3.88 from the previous earning of $3.93-$4.08 as a result of the lowering operating profit. This means that Procter and Gambler 2012 fiscal year earning per share is expected to remain flat as compared to previous fiscal EPS of $3.87. The company gross margin has decreased by 150 bases to 49% on higher inputs and negative sales while it has increased by 32.9% on restructuring charges and overhead costs. The firm is supposed to restructure if it expects to gain full potential in its future growth. This is to be achieved by mean of calibrating its pricing by either adopting initial price or by promotion. Also, the company should invest more in the developing markets where it remains under penetrating where all other firms in packaged goods are moving. Business summary Procter & Gamble Company has famous line up of packaged brands which are sold and distributed through three global business units in over 180 countries world wide. The company brands include Tide laundry detergent, Pantene shampoo, Cover Girl cosmetics and lams pet food which means the company trades in household and personal products industry. The company is rated as an AAA credit worth company by Morningstar credit rating agency in the consumer product industry. The company strength and sustainability compared to other industry player has being rated wide by Morningstar which means its competitive advantage remains high. The competitors of the company are L’Oreal SA, Reckitt Benckiser Group and Kimberly-Clark Corporation which have market capitalization of $72,309, $47720, $42799 and $30972 millions respectively compared to Procter $ Gamble CO. market capitalization of $176134 millions. This shows that Procter & Gamble Company is more capitalized than its closest rival companies. Also, the sales revenue of its competitors are $26745.83, $15196.91 and $20,846 respectively compared to Procter $ Gamble sales revenue of $85374. Total sales revenue in the industry from the above sales revenues amounts to $148162.74. Procter & Gamble Co. thus, it contributes 57.62% of the total sales revenue. From the above findings, Procter $ Gamble Company stands as the most valued company compared to its competitors. Historical performance of the company shows that the performance of the company has being on a decline path from year 2009 to date. Financial forecasting of the company is that the share value is to be raised from the current price of $72 to $75 if the $10 billion saving plan is implemented together with Pringles divesture. This implies that in 2013, ratios of price to earning will be 16.6 times and enterprise value to EBITDA to be 11.9 times while the free cash flow yield will be 6.2%. The sales growth is expected to rise by 3% in line with the new management guidance on sales growth achievement. Risks Consumer spending recently has being in a state of unconscious spending whereby the consumers are becoming more increasingly undecided on what to consume. This has resulted to manufacturers in the household and personal products industry to adopt a strategy of large and costly promotional spending in order to make huge sales. This strategy has driven the industry to experience constrained profits as it encourages consumers to expect low prices of their product. Procter & Gamble Company is thus, at risk of facing difficulty in developing and supporting successful bunch of new products and still enhance it huge top line. Also, the growing rate of the developing market which is higher than that of the full-grown markets of U.S and Europe is posing a threat to growth achievement of the company. This is because the sales realized from these markets are skewed to lower margins and are value oriented products. This scenario of negative mix shift is likely to injure the prosperity of the business in the future if the mature markets continue to drag behind in coming days (Morningstar analyses, 05/04/2012). Proctor $ Gamble company has not penetrated competitively in the developing markets which have become the largest and fastest growing market. thus, the company risks to lose dominance as it has completed in the precedent if it does not put more emphasizes on the developing markets. Valuation Valuation has being carried out by employing four valuation models namely dividend discount model, free cash flow model, residual income model and market based model (Morningstar analyses, 05/04/2012). Dividend discount model is a valuation criteria that investigates the value of common stock by means of evaluating dividend paid to common shareholders. Free cash flow model is the valuation method that is used to investigate the value of a firm and its equity on the basis of cash and cash equivalent balances. Residual income model is used to come up with the value of income of the firm after payment of tax and capital charge. Lastly, market based model is the one that is used to measure the price earning ratio of a given share in comparison to the market performance. The purpose of carrying out the valuation computation is to come up with a real reflection of the company’s book value. The rates that have being used to compute the valuation using the above are for the given models have being computed from the last five years and are as follows. (a) Risk free rate; the Treasury bill rate has being adopted as the benchmark of free rate risk since it is the least risky debt. The Treasury bill premium rate currently is 12%. (b) Market risk rate; average return on stock prices has being used to come up with the market risk rate since it represents the risk of investing in that share. (c) Beta value; the slope of the share prices in the market has being employed as the beta value since it shows the volatility of the share price in the market. (d) Dividend growth rate has being derived from the average change of dividend issued in the last five years. (e) Tax rate = (provision for income taxes/ income before tax)* 100 = (3530/13201)* 100 = 26.74% (f) A five year EPS growth rate has being used in computing market based valuation of P/ E. Dividend discount model (i) Simple dividend discount model Vo = d4/d1 + d3/d12 +d2/d13 + d1+p/ d14 Where d is the dividend and p is the price of the share. Vo = (1.64/ 2.06) + (1.8/ 2.062) + (1.97/ 2.063) + (66.34/ 2.064) = (1.64/ 2.06) + (1.8/ 4.24) + (1.97/ 8.74) + (66.34/ 18) = 0.8 + 0.42 + 0.23 + 3.69 = $5.14 (ii) Gordon dividend discount model (CFA Institute, presenter venue date) Risk free rate is 12% Beta value (price volatility) covering the last 52 weeks high and low (67.95 – 57.56)/ 57.56 = 0.18 Equity risk premium 2% CAPM r = 12% + 0.18(2%) = 12.36% Dividend growth rate = [(1.8 - 1.64)/ 1.64 + (1.97 – 1.8)/ 1.8 + (2.06 – 1.97/ 1.97] 3*100 = (0.098 + 0.086 + 0.046)/ 3*100 = 7.6% V0 = 2.06(1 + 0.076)/ (0.1308 – 0.076) = 2.22/ 0.0548 = $40.51 Free cash flow model (i) Free cash flow to the firm (FCFF) EBIT = EBITDA – Depreciation = 13731 – 3162 = 10569 Where EBITDA is earning before interest, tax and depreciation FCFF = EBIT (1 – Tax rate) + Depreciation – Fcinv – Wcinvc = 10569(1 – 0.2674) + 3162 – 3903 – 1205 = $5796.8494 Where FCinv is purchase of fixed assets while WCinvc represent the change in working capital (ii) Free cash flow to equity (FCFE) FCFE = FCFF – Int *(1 – tax rate) + net borrowing = $5796.8494 – 799 (1 – 0.2674) + (9981 + 22033) = $5796.8494 – 22618.3474 = - 6840.498 Whereby Int is the interest charge Residual income valuation Residual income= net income – equity charge (CFA Institute, presenter venue date) Net income = $9635 Equity charge = equity capital * required rate of return on equity Equity capital = total stock holder’s equity = $67640 Rate of return = 10% Equity charge = $67640*10% = $6764 Thus, residual income = $9635 – $6764 = $2871 Value based on market multiple 1) Forward P/E on basis of the past 4 years EPS; EPS for the next four years (2009)3.58 + (2010)3.53 + (2011)3.93 + (2012)3.32 = $14.36 Forward P/E which is based on the past four years = (share price)$64.28/ $14.36 = 4.48 2) Forward P/E on the basis of the current fiscal year EPS (CFA Institute, presenter venue date); Current fiscal year EPS = $3.32 Forward P/E as based on the current EPS = $64.28/ $3.32 = 19.36 3) Forward P/E valuation on the basis of the reported earning Stock price $64.28, reported EPS of the previous year $3.93 P/E = $64.28/ $3.93 = 16.36 The above valuation of Procter $ Gamble company is a true reflection of the position of the firm since the value have being derived from its financial reports. Also, the valuation is in line with the current economic trend of many consumer industry entities performance. Reference CFA Institute, presenter venue date. Morningstar analyses, 05/04/2012. Appendix Procter & Gamble Co (0P000004GV) Income Statement Fiscal year ends in June. CU$$$$$USD in millions except per share data. TTM 2011-06 2010-06 2009-06 Revenue 85374 82559 78938 79029 Cost of revenue 43335 40768 37919 38898 Gross profit 42039 41791 41019 40131 Operating expenses Sales, General and administrative 26732 25973 24998 24008 Other operating expenses 1576 Total operating expenses 28308 25973 24998 24008 Operating income 13731 15818 16021 16123 Interest Expense 799 831 946 1358 Other income (expense) 269 202 -28 560 Income before taxes 13201 15189 15047 15325 Provision for income taxes 3530 3392 4101 4032 Net income from continuing operations 9671 11797 10946 11293 Net income from discontinuing ops -25 1790 2143 Other -11 Net income 9635 11797 12736 13436 Preferred dividend 247 233 219 192 Net income available to common shareholders 9388 11564 12517 13244 Earnings per share Basic 3.4 4.12 4.32 4.49 Diluted 3.18 3.93 4.11 4.26 Weighted average shares outstanding Basic 2761 2804 2901 2952 Diluted 2954 3002 3099 3154 Procter & Gamble Co (0P000004GV) Statement of Cash Flow Fiscal year ends in June. CU$$$$$USD in millions except per share data. TTM 2011-06 2010-06 2009-06 Cash Flows From Operating Activities Net income 9646 11797 12736 13436 Depreciation & amortization 3162 2838 3108 3082 Deferred income taxes -63 128 36 596 Stock based compensation 396 414 453 516 Accounts receivable -278 -426 -14 415 Inventory 29 -501 86 721 Other working capital -1205 -832 2141 -1500 Other non-cash items 1403 -187 -2474 -2347 Net cash provided by operating activities 13090 13231 16072 14919 Cash Flows From Investing Activities Investments in property, plant, and equipment -3903 -3306 -3067 -3238 Property, plant, and equipment reductions 426 225 3068 Acquisitions, net 11 -474 -425 -368 Purchases of investments Sales/Maturities of investments 166 Other investing activities 66 73 -173 1087 Net cash used for investing activities -3400 -3482 -597 -2353 Cash Flows From Financing Activities Debt issued 3985 1536 3830 4926 Debt repayment -2083 -55 -10344 -5007 Common stock issued Common stock repurchased -6526 -7039 -6004 -6370 Dividend paid -6051 -5767 -5458 -5044 Other financing activities 2050 1302 721 681 Net cash made available by (used for) financing actions -8625 -10023 -17255 -10814 Effect of exchange rate changes -20 163 -122 -284 Net change in cash 1045 -111 -1902 1468 Cash at beginning of period 2946 2879 4781 3313 Cash at end of period 3991 2768 2879 4781 Free Cash Flow Operating cash flow 13090 13231 16072 14919 Capital expenditure -3903 -3306 -3067 -3238 Free cash flow 9187 9925 13005 11681 Procter & Gamble Co (0P000004GV) Balance Sheet Fiscal year ends in June. CU$$$$$USD in millions except per share data. 2011-06 Assets Current assets Cash Cash and cash equivalents 2768 Short-term investments Total cash 2768 Receivables 6275 Inventories 7379 Deferred income taxes 1140 Prepaid expenses 4408 Total current assets 21970 Non-current assets Property, plant and equipment Gross property, plant and equipment 41507 Accumulated Depreciation -20214 Net property, plant and equipment 21293 Goodwill 57562 Intangible assets 32620 Other long-term assets 4909 Total non-current assets 116384 Total assets 138354 Liabilities and stockholders' equity Liabilities Current liabilities Short-term debt 9981 Accounts payable 8022 Accrued liabilities 9290 Other current liabilities Total current liabilities 27293 Non-current liabilities Long-term debt 22033 Deferred taxes liabilities 11070 Minority interest 361 Other long-term liabilities 9957 Total non-current liabilities 43421 Total liabilities 70714 Stockholders' equity Preferred stock 1234 Common stock 4008 Other Equity -1357 Additional paid-in capital 62405 Retained earnings 70682 Treasury stock -67278 Accumulated other comprehensive income -2054 Total stockholders' equity 67640 Total liabilities and stockholders' equity 138354 Read More