Consumer staples giant Proctor & Gamble (NYSE:PG) reported second-quarter numbers before the bell on Wednesday that were largely better than expected. Revenues topped expectations by about 1.5%. Earnings came in roughly 3% above expectations. Organic sales growth was above consensus. The e-commerce business was red hot. Management said that they didn’t see any slowdown China. The guide was hiked.
Overall, it was a solid double-beat-and-raise quarter. PG stock rose over 4% in response. But PG stock was unable to claw its way back to the near $100 highs this stock was at in early December. Instead, the post-earnings rally maxed out short of all time highs.
Why? Valuation. Despite the strong second-quarter numbers, valuation concerns remain for PG stock. The closer this stock gets to $100 without earnings and sales heading meaningfully higher, the bigger those valuation concerns get.
Considering this is a low-single-digit revenue growth and mid-single-digit earnings growth company, it will take at least several quarters for sales and profits to head meaningfully higher. As such, it will take at least several quarters until PG stock is fundamentally supported at $100, meaning near term upside is capped by what is already a full valuation.
The Numbers Were Good for PG Stock
Proctor & Gamble’s second-quarter numbers were very good, and underscore that this company is not only surviving a global economic slowdown, but actually thriving where others are struggling.
Organic sales growth came in at 4%. That is much higher than the consensus expectation for 2.6% growth. It is also above the 1%-4% range which organic sales growth has hung out in for the past several years. More than that, consumer staples peer Kimberly-Clark (NYSE:KMB) reported just 3% organic sales growth in the same overlapping period. Also, whereas Apple (NASDAQ:AAPL) and other companies have reported material weakness in China, Proctor & Gamble said China was essentially business as usual during the quarter.
Overall, the broad top-line takeaway is bullish. Many companies are seeing their growth rates fall, or are experiencing material weakness in emerging markets. Proctor & Gamble is suffering from neither. Instead, the sales growth trajectory is improving, and emerging markets aren’t slowing.
The story on margins wasn’t as great. Gross and operating margins both came in below consensus. But, the miss on each line was 40 basis points or less. Plus, that miss was more than made up for by a hiked full year guide.
In the big picture, Proctor & Gamble had a really good quarter. But, the stock was already priced for a really good quarter, and that’s why upside from here still looks limited.
Procter & Gamble’s Valuation Is Still A Concern
A double-beat-and-raise quarter doesn’t dismantle the bear thesis on PG stock, which is predicated on an overextended valuation.
From fiscal 2014 through fiscal 2018, Proctor & Gamble’s organic sales growth ranged from 1% to 3%, while core EPS growth ranged from -2% to 8%. On average, Proctor & Gamble was a low-single-digit organic sales grower and low-to-mid-single-digit core EPS grower. That growth profile coupled with a 20 forward multiple (the stock’s average valuation over the past five years) produced sub-par returns for PG stock.
Over the past five years, PG stock has risen less than 20%, while the S&P 500 is up more than 40% during that stretch.
Clearly, a 20 forward multiple on a low single revenue growth and low to mid single digit earnings growth profile didn’t cut it for PG stock over the past five years. Considering rates are only going up and the global economy is only slowing, such a combination won’t cut it for PG stock over the next five years, either.
Unfortunately, PG stock today is defined by a very similar dynamic. Organic sales growth this year is expected at 3%. Core EPS growth is expected at 5.5%, and that’s a three year low. Thus, over the next five years, a reasonable estimate for PG’s growth profile is low-single-digit revenue growth and low-to-mid-single-digit EPS growth, the same as it has been over the past five years. Meanwhile, the forward P/E multiple today is just a hair below 20, nearly identical to where it’s hovered over the past five years.
Thus, PG stock today is very similar to its “average self” over the past five years. That “average self” resulted in 20 points of under-performance relative to the S&P 500. As such, there really isn’t much reason to get excited about PG stock here.
Bottom Line on PG Stock
Proctor & Gamble is a great company with solid and defensive fundamentals. The company isn’t going anywhere anytime soon, and steady earnings growth is almost a guarantee.
But, today’s valuation already accounts for all those positives. Upside in PG stock from here in any time frame looks limited. As such, the post-earnings rally isn’t anything to get too excited about.
As of this writing, Luke Lango was long AAPL.