A Blue Chip Making Bold Moves

01/31/2008 12:00 am EST


Stephen Biggar

Director, Product Strategy, Argus Research Corporation

Stephen Biggar, Standard & Poor’s global director of equity research, says Procter & Gamble may make some big changes to boost growth and profits.

On January 11th, Standard & Poor’s kept its Strong Buy ranking on Procter & Gamble (NYSE: PG) following reports [that] the company plans to spin off its Folgers coffee business [and] unconfirmed reports [that] P&G was considering the sale of its Pringles and Duracell businesses. P&G has said it wants to focus on its faster-growing areas, such as beauty and health care.

Our Strong Buy opinion reflects our confidence that P&G will deliver consistent sales and earnings growth near the high end of its peer group over the next several years. Also factored in are expected benefits from the Gillette acquisition and growth prospects in new markets and categories.

We think P&G is in a position to benefit from demand for household and personal care products in developing countries, given its broad product portfolio and sizable distribution network. We think that P&G has ample room to grow in developing markets, which accounted for just 27% of its sales in fiscal 2007. (The company’s goal is 30% by fiscal 2010.) 

In addition, we believe P&G has a more attractive portfolio of businesses now than it had six years ago: the faster-growing and [more profitable] businesses of beauty, health care, and home care accounted for more than half of sales in fiscal 2007.

We think P&G will be able to reach its goal of a nearly 24% operating margin by fiscal 2010 by successfully integrating Gillette, continuing its emphasis on innovative products, shifting sales to the more profitable segments, securing more low-cost supply sources, and continuing to consolidate its distribution centers.

We also think the company will be able to reach its long-term financial goals—4% to 6% sales growth, double-digit net operating earnings growth, and free cash flow equal to 90% or more of net earnings.

Ahead of P&G’s quarterly earnings report, scheduled for January 31st, we forecast revenue growth of 7.2% and earnings growth to 96 cents a share vs. 84 cents a year ago. We expect the company to report a wider operating margin, lower net interest expense, and a lower tax rate. (The company reported earnings of 98 cents a share and sales rose 9%, beating expectations—Editor.)

For fiscal 2008 (ending in June), P&G should report 6.9% revenue growth and earnings of $3.49 a share. Based on the company’s strong track record of earnings growth and leading market positions, we believe the stock should trade at a premium to peers. This leads us to a target price of $82, which is 22.2x our 2008 calendar earnings estimate of $3.69. (The stock closed above $65 Wednesday—Editor.)

Risks to our recommendation and target price include a rise in raw material costs that cannot be offset through pricing or productivity [increases] and an insufficient amount of successful new products. The household products area [also] remains very competitive.

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