Proctor & Gamble’s Cash Flow Bests Peers, Justifies 20% Upside

PG: Procter & Gamble logo
Procter & Gamble

With over 170 years of “touching lives and improving lifeacross the globe, Procter & Gamble (NYSE:PG) continues to provide consumers with quality beauty and personal care products. Headquartered in Cincinnati, P&G draws around 41% of its sales from North America with Western Europe contributing another 21% to its total sales. P&G competes with companies like Unilever (NYSE:UL), L’Oreal (PINK:LRLCY), Colgate-Palmolive (NYSE:CL), Kimberly Clark (NYSE:KMB) and is one of the stocks that scores the best in our cash conversion analysis included below.

P&G is heavily exposed to developing markets, which now contributes close to 32% of its business. With new CEO, Robert McDonald’s, ambitious plan of acquiring a billion new consumers by 2014-15, we can only expect P&G’s presence to increase in the emerging markets of China and India growing at double-digit growth rates.

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We currently have a $75.25 valuation for P&G’s stock which is just around 20% higher than the current market price.

Cash is King — and Leads to Returns

For most investors, what matters is how much cash he or she makes from a stock, which includes both dividends and stock appreciation. We have analyzed the cash position at P&G and compared it with its peers in the beauty and personal care industry.

Here we’ve examined three parameters: (i) the cash conversion ratio (measured by free cash flows % total revenues), (ii) dividends to free cash flows ratio (cash dividends as a % free cash flows) and (iii) revenue growth projections (2010-15 CAGR) to evaluate our estimates of the cash position in the leading players in the beauty and personal care industry.

P&G is a Cash Cow

P&G has an impressive cash conversion ratio (free cash flows as a percentage of sales) of 14% vs. its peers. The cash conversion ratio shows how efficiently a company converts sales to cash and implicitly captures operational efficiencies. P&G is the largest consumer goods company in the world and the economies of scale can be partly attributed to the high operating margins.

Many investors take the dividend policy into consideration while investing in a stock, particularly of stable and mature companies. The company could be generating cash but investors like to see the management distribute this cash to the shareholders or plow it back into the business, which should then appear in higher growth.

Here again, P&G maintains a healthy dividend payout ratio and pays its shareholders almost 48% of its free cash flows by our estimates. We are a little conservative with regards to P&G’s revenue growth forecasts at around 4% predominantly on account of the increasing proportion of volumes coming from emerging markets, behind lower priced product variants.

See our full estimates for P&G.

P&G’s Improving Cash Position

P&G’s overall cash position has improved in 2010 with net debt /cash rising to 1.5 and debt coverage ratio (EBITDA/interest payment due on outstanding debt) rising to historically high levels of almost 23 in 2010. While P&G’s closest competitor, Unilever has been on an acquisition spree lately with its recent acquisition of Sara Lee’s personal care and European laundry business and its purchase of Alberto-Culver, we believe P&G could look to make acquisitions to help boost growth in emerging markets where it is eyeing growth.