Any time a blue-chip stock tumbles as much as Procter & Gamble (PG) did Thursday, you need to take a closer look. After all, the idea is to buy low, and surely PG stock must have something going for it.
Earnings managed to beat Wall Street estimates thanks to cost cuts, but that’s about it for good news. Sales fell for a sixth consecutive quarter. True, the strong dollar continued to weigh on results, but even after stripping out currency effects — as well as acquisitions and divestitures — organic sales rose just 1%.
It’s not a big deal when a company beats on the bottom line but misses on revenue this earnings season — it happens all the time, especially lately. What the market really can’t stand — nor should it — is a downbeat forecast, and that’s just what P&G served.
A stock’s price is supposed to represent the estimated value of future earnings. When a company says that estimated earnings aren’t going to be as high Street forecasts, shares have to come down. It’s simple arithmetic.
However, that doesn’t mean the market’s initial reaction to such news is proportionate and rational. Indeed, it rarely is, and that’s why this move in PG stock could represent a buying opportunity.
To get a sense of whether PG stock is a good bet at current levels, let’s take a look at the pros and cons.
PG Stock Pros
A Knee-Jerk Reaction: PG stock fell as much as 4.3% soon after the opening bell. That means roughly $2 billion in shareholder value disappeared in about 15 minutes. Sure, P&G offered a muted and uncertain outlook — it doesn’t even know if full-year profits will increase or decrease year-over-year. But is PG stock really worth $2 billion less than it was yesterday?
Productivity Gains: Like so many other companies these days, P&G is shrinking to become more profitable. Shedding scores of lower-margin brands is good thinking, and underneath the accounting mess it leaves, P&G looks much improved. After stripping out restructuring costs and the the hit from forex, earnings per share rose 22% year-over-year.
New CEO: This one could go either way in the long run, but for now you can bet that the market will give new Chief Executive David Taylor the benefit of the doubt for a quarter or two. Current CEO A.G. Lafley had a fantastic run with P&G his first time around, but that was back when P&G was in expansion mode. Perhaps new blood will be better suited to shrinking PG.
PG Stock Cons
The Easy Fixes Are Over: These saying may be cliches, but they’re also true: Most turnarounds don’t turn, and you can’t cut your way to growth. P&G has axed costs, cut jobs and ditched nearly 100 brands since Lafley took over two years ago, and yet growth continues to languish — even off a smaller base. Organic sales will be little changed this year, PG said.
Macro Troubles: The macroeconomic situation is a huge headwind for PG stock. Sluggish global growth — especially in once-hot emerging markets like Brazil, China and Russia — is hurting sales. The strong dollar is nothing but pain. And the dumpster fire that is Venezuela forced P&G to take a charge of $2.1 billion in the quarter — a 71-cent hit to EPS.
Valuation: PG stock looks pricey. The Street forecasts full-year EPS at $4.19 (a figure that’s sure to come down.) That means PG stock was trading at 19 times forward earnings before it gave a muted forecast. That’s too high for a stock with less than 6% annual EPS growth. Moreover, unless shares keep selling off, the price-to-earnings ratio is actually going to rise as analysts cut estimates.
The market is frustrated with the glacial pace of P&G’s turnaround, and it’s right to be. The turnaround is two years in the making, and it still hasn’t turned. (Note that PG stock hasn’t gone anywhere since 2013.) Worse, the company just said it won’t make the turn this year either.
That lack of fundamental progress underscores how absurd the valuation has become. Heck, the S&P 500 is by no means cheap, but it’s cheaper than PG stock — and it has better growth prospects.
PG doesn’t deserve a premium valuation, not when it has yet to show meaningful growth from its massive restructuring, and the macro picture remains bleak.
PG stock price has a lot farther to fall before it becomes a buy. Maybe if it drops another 5% to 8%, it might be worth a second look.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.