Steady As She Goes

05/21/2009 10:45 am EST


Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, editor of Morningstar StockInvestor, and analyst Lauren DeSanto say Procter & Gamble remains one of the bluest of blue chips and its price is attractive.

Since its founding in 1837, Procter & Gamble (NYSE: PG) has become the world's largest consumer product manufacturer, with a lineup of famous brands [including] Tide laundry detergent, Charmin toilet paper, Pantene shampoo, Cover Girl cosmetics, and Iams pet food.

The company's leading brand positions allow it to be a price leader in its categories and give P&G unparalleled marketing firepower. [Its] broad lineup of brands brings balance to the company and gives it a baseline of relatively consistent, predictable growth. With so many brands and such tremendous global reach, it would be easy for the firm to become bloated with unnecessary overhead, but management has its eye trained on controlling costs.

P&G completed its acquisition of Gillette in October 2005, adding new brands to the fold and boosting P&G's global reach and top-line growth rate. Now, after successfully integrating Gillette, the firm has directed its efforts toward improving productivity. The renewed focus on productivity is undoubtedly warranted after absorbing Gillette, and after battling rising input costs and a pullback in consumer spending, P&G is wise to squeeze any costs out of the system. Knowing P&G, we doubt the firm will go off the rails with its productivity efforts.

The firm estimates that since 1980, productivity has improved 6% annually, based on metrics such as sales per employee. P&G's management believes it can improve productivity to 7%-8% annually by putting strict controls on overhead growth, depending on what stage of development a business unit is in. Since 2001, it has doubled the sales it derives from developing markets.

We believe that P&G's moat will remain relatively stable over time because of its scale advantages in purchasing and distribution, and its core competence in building consumer interest and loyalty in its brands. The firm facilitates this loyalty with its strategy of offering an array of products at various price points within each of its categories.

Significant R&D and marketing investments to support its brands, as well as a broad product portfolio, help P&G keep competitors from taking market share in good times and bad. Since P&G generates healthy returns on invested capital and consistent cash flows, there is a low degree of uncertainty around our $77 fair value estimate, [so] we think the shares are worth considering below $62. (It closed around $54 Wednesday—Editor.)

We think that the firm will deliver roughly 4% sales growth on average over the next five to ten years. This is in line with P&G's longer-term target of 4% to 6% annual internal sales growth. The company has also been focused on cost-cutting efforts, but increased input costs and fewer sales from higher-margin categories will probably limit any meaningful near-term margin expansion.

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