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March 21, 2010

Consumer Staples (Household Products)

March 21, 2010 Consumer Staples (Household Products) Henry Fund Research P r o c t e

Henry Fund Research

Consumer Staples (Household Products) Henry Fund Research P r o c t e r & G

Procter & Gamble (PG)

Investment Recommendation

BUY

Sumit Taneja

Sumit-taneja@uiowa.edu

Current Price

$63.69

Target Price Range

$72-76

Current Price $63.69 Target Price Range $72-76 Source 1 : http://finance.yahoo.com Key Stock Statistics

Source 1 : http://finance.yahoo.com

Key Stock Statistics

52-Week Price Range Market Capitalization (B) Shares Outstanding (M) Institutional Ownership 60-Month Beta Dividend Yield Price/Earnings (ttm) Price/Book Price/Sales ROA (ttm) ROE(ttm) Projected 5-Year Growth

$45.52-64.00

$185.43

2900.00

58.70%

0.59

2.80%

15.21

2.75

2.34

6.67%

17.61%

9.33%

EPS ($)

Year

2007

2008

2009

2010E

2011E

2012E

EPS

3.22

3.86

4.49

4.11

4.04

4.18

All earnings represent earnings from operations and have been filtered from net nonrecurring gains.

Valuation Models

Discounted Cash Flow & EP Relative P/E Dividend Discount Model

$89.60

$62.25

$70.32

Average

$74.05

INVESTMENT THESIS

(+)Procter & Gamble is the largest consumer goods company with strong financials and stable cash flows. The company has been very strong in new product innovation. Even during the economic downturn the company was not affected badly because the demand for its products remained somewhat stable.

(+)The intrinsic value of Procter & Gamble’s share is $74.05 which is the average of all the valuation models. This is 16% higher than the current price and makes it a good investment opportunity.

(+)Procter & Gamble generates 57% of its revenue from overseas markets, this adds to the geographic diversification and minimizes the effect of a downturn in the US.

(+)Procter & Gamble has increased its focus on emerging markets; currently it has 32% of its revenue from emerging markets. These markets offer higher growth opportunities in the future.

(+)Procter & Gamble has been involved in continuous product portfolio restructuring and strengthening through acquisitions and divestitures. The major acquisition of Gillette and other companies in the future will help improve revenue synergies and enable cost savings.

(+)Procter & Gamble has a clear focus to grow its core, which consists of 43 brands that contribute 85% of the revenue. The company is increasingly

changing focus to its higher margin products.

(-)Volatility in commodity prices can affect profit margins of Procter & Gamble’s products because the US consumer goods market is very competitive and it will not be possible to pass all price increases to the consumer.

(-)During the current downturn, consumers have traded down to lower priced products. If this trend continues then it will negatively impact Procter & Gamble’s high price and high margin product sales.

Henry Fund Research

THE UNIVERSITY OF IOWA

Henry B. Tippie School of Management

EXECUTIVE SUMMARY

Procter & Gamble is one of the largest consumer products company. Its products are sold in over 180 countries and as of June 30, 2009 it has on ground operations in about 80 countries. Market capitalization of Procter & Gamble is greater than the GDP of many countries. Since 1837, the company has built a rich heritage of touching lives of millions of people because of consumer research, strong management and receptiveness to change.

Procter & Gamble will continue to generate higher revenue and earnings growth and higher return on invested capital because of its brand leadership, scale advantages, diverse portfolio of products and global expansion. Procter & Gamble also has a very strong cash and cost management. Its strong financial position and share repurchase policy will generate additional value for shareholders.

COMPANY DESCRIPTION

Procter & Gamble is the largest consumer nondurables manufacturer and distributor of branded nondurable consumer goods with presence in 180 countries. Procter & Gamble is engaged in providing branded consumer goods products and its products are sold through retail operations including mass merchandisers, grocery stores, membership club stores, drug stores, department stores, salons and high-frequency stores. P&G’s revenue has doubled in the last 10 years. Revenue figures are plotted for the last ten years in the figure below:

Revenue in $ millions

100,000 80,000 60,000 40,000 20,000 0 Source 2 : www.mergentonline.com
100,000
80,000
60,000
40,000
20,000
0
Source 2 : www.mergentonline.com

The company offers a wide range of products in personal care, household care health care and snacks.

It’s organizational structure is comprised of three Global Business Units(GBUs) and a Global Operations group. The Global Operations group consists of the Market Development Organization (MDO) and Global Business Services (GBS).

Global Business Units ( GBU’s)

Procter & Gamble’s three global business units are Beauty, Health Care and Well-Being, and Household Care. Revenue and Net income contribution for the

year 2009 in the pie charts

GBUs is shown for the below:

Revenue Contribustion by GBUs 2009

Household care, 47% Health & well being, Beauty, 21% 32%
Household
care, 47%
Health &
well being,
Beauty,
21%
32%

Source 3 : Annual report 2009

Net Income contribution by GBUs 2009

Household care, 42% Health & well being, Beauty, 23% 35%
Household
care, 42%
Health &
well being,
Beauty,
23%
35%

Source 3 : Annual report 2009

GBU-Beauty

Beauty & Grooming is a $300 billion market and P&G is leading, but with only a 13% share. The Beauty GBU

Beauty & Grooming is a $300 billion market and P&G is leading, but with only a

2

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includes the Beauty and Grooming businesses. The Beauty business includes cosmetics, deodorants, prestige fragrances, hair care, personal cleansing and skin care. The Grooming business is comprised of blades and razors, electric hair removal devices, face and shaving products and home appliances.

The Beauty GBU has eight billion-dollar brands: Head & Shoulders, Olay, Pantene, Wella, Braun, Fusion, Gillette and Mach3.

Beauty revenue was down 4% in 2009 on a 2% unit decline because of the economic downturn. Volume in developed markets declined by mid single digits but the volume in developing regions grew by low single digits.

Grooming revenue was down 9% in 2009 on 6% volume decline. Volume in developed regions declined by high single digits and volume in developing regions declined by mid single digits.

In the future we expect the Beauty GBU to have the higher growth for Procter & Gamble as this segment has the highest margin and the company is increasing focus in this area.

GBU-Health and Well-Being

Consumer Health Care is a $240 billion market; Procter & Gamble has a 5% market share. The Health and Well-Being GBU includes the Health Care and the Snacks and Pet Care businesses. The Health Care business includes feminine care, oral care, personal health care and pharmaceuticals. The Snacks and Pet Care business includes pet food and snacks.

The Health and Well-Being GBU has six billion-dollar brands: Actonel, Always, Crest, Oral-B, Iams and Pringles.

In the Health care segment Procter & Gamble’s margin has been improving over the years, from 24% in 2006 to 27% in 2009. It plans to lay more focus on its higher margin businesses which will be good in the long term.

In the Snacks category Procter & Gamble does not have a large product offerings; Pringles is the only large brand in the suite of products. Pringles has a 10% market share of the global chips business. In the Pet- care market also Procter & Gamble has almost 10% market share in North America, with brands like Iams and Eukanuba.

GBU- Household care

Global Household Care is a $200 billion marketand P&G’s global share is about 20%. The Household Care GBU includes Fabric Care and Home Care as well as Baby Care and Family Care. The Fabric Care and Home Care business includes air care, batteries, dish care, fabric care and surface care. The Baby Care and Family Care business includes baby wipes, bath tissue, diapers, facial tissue and paper towels.

The Household Care GBU has nine billion-dollar brands: Ariel, Dawn, Downy, Duracell, Gain, Tide, Bounty, Charmin and Pampers.

For the last two years the company has been involved in dramatic simplification by brand and platform optimization. This initiative will help the company to have 40 active brands by June 2011, down from 60 Global Fabric Care active brands in June 2007. By this simplification the Global Fabric Care production platforms will be reduced from 53 in June 2007 to 20 in June 2011 6 .

Research & Development, Innovation and Marketing

The organic sales growth in the last nine years has come from new brands and new or improved product innovation. Procter & Gamble is the innovation leader in the industry because it invests heavily in R & D, much more than any of its competitors. The graph below shows R&D expense for the last eight years:

R&D Expense in $ million

2500

2000

1500

1000

R&D Expense in $ million 2500 2000 1500 1000 2002 2003 2004 2005 2006 2007 2008

2002 2003 2004 2005 2006 2007 2008 2009

Source 4 : Company Financials

For Procter & Gamble, marketing is not a discretionary expense. Marketing expenses include media advertising, promotional coupons, trade promotions and event sponsorships. The graph below shows the company’s advertising expense for last eight years

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Henry B. Tippie School of Management

Advertising Expense in $ millions

10000

8000

6000

4000

2000

0

Advertising Expense in $ millions 10000 8000 6000 4000 2000 0 2002 2003 2004 2005 2006

2002 2003 2004 2005 2006 2007 2008 2009

Source 4 : Company Financials

Global Operations

Procter & Gamble is in the leading position in the consumer nondurables industry. Procter & Gamble has built the strongest portfolio of brands in the industry with 23 billion-dollar brands and 20 half-billion-dollar brands. These 43 brands account for 85% of sales and more than 90% of profit. Twelve of the billion-dollar brands are number one global market share leaders of their categories. The majority of the balance are number two. Procter & Gamble’s billion-dollar brands have grown sales at an average rate of 11% per year for the entire decade. Procter & Gamble is truly a global company with on the ground operations in 80 countries. Its status is also evident from the percentage of revenue it earns from the overseas market as shown in the graphs below:

Revenue by Geography 2009

Rest of the world

US 25% 43% Developing Markets 32%
US
25%
43%
Developing
Markets
32%

Source 3 : Annual report 2009

Over the past years the percentage of sales from international markets has been increasing, especially from developing markets. We feel that this trend will continue in the future; maximum revenue growth will come from emerging markets.

Revenue by Geography 2008

Rest of the world

US 27% 42% Developing Markets 31%
US
27%
42%
Developing
Markets
31%

Source 5 : Annual report 2008

RECENT DEVELOPMENTS

Acquisitions and Divestitures

In December, 2009, Procter & Gamble signed a binding offer with the Sara Lee Corporation to acquire Ambi Pur for $470 million. This acquisition will help Procter & Gamble strengthen its global leadership position in Home Care, specifically in Air Care.

In August 2009, Procter & Gamble and Warner Chilcott Plc announced an agreement for the sale of Procter & Gamble's global pharmaceuticals business to Warner Chilcott for an up-front cash payment of $3.1 billion. This move enables Procter & Gamble to focus on personal health care, oral care and feminine care.

In November 2008, Procter & Gamble completed the divestiture of its coffee business through the merger of Folgers coffee subsidiary into The J.M. Smucker Company (Smucker) in an all-stock reverse Morris Trust transaction. Procter & Gamble recorded an after- tax gain on the transaction of $2.0 billion.

The consumer products industry is becoming extremely competitive. Procter & Gamble has been focusing on building its core brands and making acquisitions and divestitures to strengthen its product portfolio.

Restructuring and Simplification

Procter & Gamble has also been involved in streamlining management structure. The company plans to increase productivity by reducing its employee count at certain levels in the organization. It has a target to reduce V.P. and above level by 15% and the next two levels by 15% by June 2010 from the base level of June 2007.

Revenue per employee has grown from $363,000 in

2000 to $585,000 in 2009, and profit per employee has increased from $32,000 to $84,000. Procter & Gamble has doubled the productivity of its R&D organization

since 2000 even as it has become more innovative

3

.

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For the last two years, Procter & Gamble has been involved in simplification of its businesses. The figures below show the path and target for this process for Fabric Care. This trajectory will help the company to reduce cost and have a competitive advantage.

the company to reduce cost and have a competitive advantage. Source 6 : P&G presentation at

Source 6 : P&G presentation at CAGNY Conference Feb2010

6 : P&G presentation at CAGNY Conference Feb2010 Source 6 : P&G presentation at CAGNY Conference

Source 6 : P&G presentation at CAGNY Conference Feb2010

Growth opportunities in Emerging Markets

Eighty-six percent of the world’s population is in developing markets and Procter & Gamble has strong share positions in the most important of these markets. In Blades and Razors, it is number one in Central and Eastern Europe, the Middle East, Africa, Latin America, greater China and developing Asia. In shampoo and diapers, it is number one or two. In laundry, feminine care and oral care, it is ranked number one, two and three in the market share, respectively.

Recently Procter & Gamble made an aggressive entry in the mass-end priced detergent segment in India with

Tide Naturals, which is priced at Rs 20 for a 400gm pack. About 80% of detergents are priced in this band, which gives Procter & Gamble access to a large segment in India.

As growth in developed economies stagnates, Procter & Gamble has been increasing its focus on emerging markets. This trend is visible from the chart below which shows the percentage of revenue from developing markets:

% Revenue from Developing Markets

32% 31% 30% 29% 28% 27% 26% 2007 2008 2009
32%
31%
30%
29%
28%
27%
26%
2007
2008
2009

Source 3 : Annual report 2009

Business Segments Growth

Below is the chart that shows the trend for before tax profit margins for different business segments:

30% 20% 10% 2006 2007 2008 2009 Beauty Grooming Health Care Snacks and Pet care
30%
20%
10%
2006
2007
2008
2009
Beauty
Grooming
Health Care
Snacks and Pet care

Fabric Care and Home Care30% 20% 10% 2006 2007 2008 2009 Beauty Grooming Health Care Snacks and Pet care Baby

Baby Care and Family Care30% 20% 10% 2006 2007 2008 2009 Beauty Grooming Health Care Snacks and Pet care Fabric

Source 2 : Company Financials

As

grooming, health care and baby care and family care so Procter & Gamble is increasing focus on these businesses.

we can see, the profit margins are higher in

INDUSTRY TRENDS

In the last two decades most major US household nondurable companies became global through a spree of acquisitions. Recently, the major players in this

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Henry B. Tippie School of Management

sector have been involved in restructuring and reducing costs, and these efforts promise further profit expansions. For instance, after acquiring razor maker Gillette Co in October 2005, Procter & Gamble has been shedding product lines and closing other facilities and plants to maximize profits. P&G plans to shed products that do not meet minimum financial targets or show slower potential for growth. Other companies like Kimberly Clark Corp., Colgate-Palmolive Co., Unilever NV and Avon Products Inc have all been involved in different restructuring and cost optimizing initiatives.

We feel that this will help the industry to show better results in the future. For the year 2010, we project mid single digit revenue for both household products and personal care companies. There will be operating margin improvements from sales leveraging and various cost reduction and restructuring programs. An EPS growth of around 10% for the household product companies and 10% to 20% for personal care companies is expected.

Recently there has been a lot of media attention on retailers pressing manufacturers for price reductions. We don’t expect to see any extensive price cuts, but if there are cuts, they would be strategic in naturei.e. in a particular market or product size or category. Most household nondurables companies have still not caught up with the three years of above average commodity cost increases. For example, in a presentation in 2009, Kimberly Clark said that in the last five years, it had price increases of $1 billion while the cost of commodity increased by $2 billion. Kimberly Clark has been able to offset half of this cost through efficient manufacturing and various cost control programs.

As the recession hit most economies after 2007, there customers changed their buying behaviors. Private label products gained market share in the laundry detergent, razor, and razor cartridges categories, but still are under 5%. Private label mostly increased market share in categories where it held between 15% and 24% share, in categories like facial tissue, toilet tissue, and disposable diapers. Keeping this trend in view manufactures have increased their emphasis on ―value.For example, in the summer of 2009 P&G started distribution of Tide Basic, which cost 20% less than regular Tide and does not have all of the same capabilities. Previously, P&G also introduced Charmin Basic and Bounty Basic.

The companies have also been trying to reach consumers through nontraditional channels. In July 2009, Kimberly Clark’s Huggies launched a multiphase campaign. The first phase involved putting on packs of diapers, telling parents to text ―potty‖ or ―bigkid‖ to

receive potty training kits and other resources to help with the potty training process. The second phase involved arranging a phone call where Disney characters congratulate the child on her or his potty training. The final phase gave parents access to more Disney voices and messages by entering a proof of purchase. This program could encourage product purchase without lowering the prices. Other examples included, introducing a Virtual makeover Widget by Estee Lauder in August 2009 that allowed online customers to see how makeup products look on their own face and launching mobile applications named SitOrSquat for Blackberry and iPhone, by Charmin, to help consumers find free, clean public toilets anywhere in the world.

MARKETS AND COMPETITION

Two companies Procter & Gamble and Unilever account for roughly half of the worldwide sales in consumer nondurables. The major competitors to Procter & Gamble in the global consumer nondurable products industry are Unilever Plc, L’Oreal SA, Kimberly-Clarke and Colgate-Palmolive.

Procter & Gamble is the undisputed leader in the industry, with the largest product portfolio as well as the highest geographic reach. In 2009, it generated $79 billion in sales, far above Unilever’s $53.7 billion, the second ranked player in the industry.

$53.7 billion, the second ranked player in the industry. Source 7 : S&P Net Advantage Industry

Source 7 : S&P Net Advantage Industry report.

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Henry B. Tippie School of Management

Unilever Plc

Unilever is a UK based consumer nondurables goods Company and Procter & Gamble’s biggest competitor. Unilever manufactures and markets goods in the food, home and personal care categories. Unilever competes with Procter & Gamble very closely in most of home and personal care products. Unilever offers stiff competition to P&G in low-end markets. In the personal care category, UL has strong product line in hair care, deodorants, skin care and skin cleansing, with Sunsilk, Rexona, Lux, Axe, Pond’s and Dove being the large, global brands. Unilever also has a powerful presence in oral care with Close-up and Signal being two popular brands. Unilever’s home care product portfolio includes laundry products like laundry detergent, liquids and tablets. It also manufactures soap bars for low-income consumers. Unilever’s home care brands include Surf, Snuggle, Radiant, Cif and Domestos.

Kimberly-Clark Corp.

Kimberly Clark is a strong competitor to Procter & Gamble in personal care, health care and consumer tissue segments. Kimberly Clark is also a global player with brands like Kotex, Kleenex, Huggies, Depend and Pull-Ups. The company has grown rapidly in the last decade, with robust organic growth as well as many acquisitions.

Colgate-Palmolive

Colgate is one of the leading manufacturers of consumer goods in oral, personal and home care segments and the pet Nutrition segment. Although Colgate is roughly 10% of Procter & Gamble in market capitalization, it offers tough competition to P&G in all its product categories. Colgate’s leading brands are Colgate, Palmolive, Irish Spring, Softsoap and Protex.

ECONOMIC OUTLOOK

The consumer staples sector in general and household nondurable industry is somewhat recession resistant but not recession proof. With the weak economy consumers tend to change their buying behaviors and that has a negative effect on the premium brands by household nondurables. Thus, the profit margins could be squeezed if the economy does not start bouncing back.

GDP

The US GDP growth came back to posititive after four quarters of contraction. Even though the economy

expanded on an annualized rate of 5.7% in the forth quarter of 2009, it might not be an indication of a stronger than expected recovery. Growth was mainly due to inventory rebuilding. Moving forward we forsee an annual growth of 2.35% for 2010. With the recovery in global economy Procter & Gamble will be able to grow its revenue for more discritionary products that are also more profitable.

more discritionary products that are also more profitable. Source 8 : US Bureau of Economic analysis

Source 8 : US Bureau of Economic analysis

Unemployment Rate

Another indicator of economic health is the unemployment rate. Recently the unemployment rate touched the record high of 10.1% for the last 26 years. The latest figue is 9.7% for the month of February 2010. We feel that their will be improvemnet is the unemployment rate as President Barak Obama has declared that job creation will be his top priority for 2010. As unemployment gets better, consumers will start spending more and trade up on the household nondurable products.

will start spending more and trade up on the household nondurable products. Source 9 : www.tradingeconomics.com

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Consumer Confidence

In early 2009 the consumer confidence index also was at its lowest in the last few decades. We feel that there will be moderate improvement in this level in the near future. The past trend for the last nine months is shown below:

The past trend for the last nine months is shown below: Source 1 0 : http://www.conference-board.org

Source 10 : http://www.conference-board.org

below: Source 1 0 : http://www.conference-board.org Source 1 1 : http://www.bea.gov/ The figure above

Source 11 : http://www.bea.gov/

The figure above shows the percentage change in disposable income and consumer spending since October 2009. We expect consumer spending to increase gradually over the next year. A decline in consumer spending will effect Procter & Gamble’s products negatively.

Inflation

The US economy was a deflationary enviornment from March 2009 to November 2009; currently inflation is at 2.7%. Inflation does not seem to be a big worry in the near future. Increase in inflation can increase problems for consumers. According to the data from US

Department of Commerce the producer price index increased by 350bps in 2009. So far, Procter & Gamble has been able to pass on some price increase to the consumers but an unexpected increase in raw material prices would have a negative effect on the revenue.

Table A. Monthly and 12-month percent changes in selected stage-of-processing

price indexes, seasonally adjusted

Finished goods

Intermediate

Crude

Month

goods

goods

2009

Feb.

-0.2

-1.5

0.2

0.1

-1.4

-0.8

-6.1

Mar.
Mar.

-0.8

-0.8

-3.8

0.2

-3.4

-1.3

-0.6

Apr.
Apr.

0.6

1.6

1.4

0.1

-3.5

0.1

2.4

May

0

-1.4

1.8

-0.1

-4.8

0.5

3.2

June

1.8

1

7.6

0.3

-4.4

1.1

4.3

July
July

-1.2

-1.3

-4.5

-0.1

-6.9

-0.5

-3.3

June 1.8 1 7.6 0.3 -4.4 1.1 4.3 July -1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3
June 1.8 1 7.6 0.3 -4.4 1.1 4.3 July -1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
-1.2 -1.3 -4.5 -0.1 -6.9 -0.5 -3.3 Aug. 1.5 0.3 6.2 0.3 -4.4 1.7 4.5
Aug.
Aug.

1.5

0.3

6.2

0.3

-4.4

1.7

4.5

Sept.

-0.5

0

-1.8

-0.1

-4.9

0

-2.2

Sept. -0.5 0 -1.8 -0.1 -4.9 0 -2.2 Oct.(1) 0.2 1.3 1.2 -0.5 -2 0.4
Sept. -0.5 0 -1.8 -0.1 -4.9 0 -2.2 Oct.(1) 0.2 1.3 1.2 -0.5 -2 0.4

Oct.(1)

0.2

1.3

1.2

-0.5

-2

0.4

7

Nov.(1)
Nov.(1)

1.7

0.7 6.3

0.5

2.4 1.4

4.2

Dec.
Dec.

0.4

1.3

0.7

0

4.4

0.6

0.8

2010

 

Jan.

1.4

0.4

5.1

0.3

4.6

1.7

9.6

Jan. 1.4 0.4 5.1 0.3 4.6 1.7 9.6 Feb. -0.6 0.4 -2.9 0.1 4.4 0.1 -3.5

Feb.

-0.6

0.4

-2.9

0.1

4.4

0.1

-3.5

 
 

Source 12 : US Department of Commerce statistics

Exchange Rate

In the first half of 2009 strengthening of the US dollar against other currencies affected the earnings of household nondurables companies that have a larger share of their revenues from overseas. From May 2009 until the end of 2009, US dollar weakened; recently, it has again shown strength. With the current crisis in the European PIIGS countries and problems in Japan, the US dollar might strengthen again in the short term. and That could affect Procter & Gamble because a strong dollar means a reduction in dollar revenue from overseas operations, which contribute around 60% of the revenue.

Euro vs $US
Euro vs $US

Source 1 : http://www.finance.yahoo.com

overseas operations, which contribute around 60% of the revenue. Euro vs $US Source 1 : http://www.finance.yahoo.com

8

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Yen vs $US
Yen vs $US

Source 1 : http://www.finance.yahoo.com

CATALYSTS FOR GROWTH

New products innovation will remain an important driver for growth. As population growth in the US is slow, the development of new products and categories remains the important factor for growth in the consumer products industry. New product development also increases profit margins and innovation keeps customers from switching to private label products. Procter & Gamble has 30% more innovation in the pipeline in 2010 as compared to previous years 6 .

the pipeline in 2010 as compared to previous years 6 . Source 7 : S&P Net

Source 7 : S&P Net Advantage Industry report

Procter & Gamble has been investing heavily in emerging markets in Central and Eastern Europe, China and India. In most of these economies GDP and population growth are outpacing those of the United States and Western Europe. Increase in the disposable income in these countries is enabling consumers to demand world-class products. Stronger demand from overseas operations will be a big growth opportunity for the consumer nondurables industry. If current trends continue, by 2030, there will be more than 350 million Chinese who meet the World Bank’s classification of

middle class. These are the people who buy cars, engage in international tourism, demand world class products, and require international standards of education.

Procter & Gamble will be able to grow by targeting baby boomers (approximately 77 million Americans born between 1946 and 1964). These individuals are very sensitive about their looks thus skin care and hair coloring are two categories that have shown strong sales growth in recent years. Procter & Gamble has been very active introducing products targeting this category of consumers.

Procter & Gamble’s future growth is also dependent on its ability to acquire new companies and divest from products that help strengthen existing products and increase both the top line and the bottom line.

INVESTMENT POSITIVES

The intrinsic value of Procter & Gamble’s share is $77.78 which is 22% higher than the current prevailing price of $63.69.

Procter & Gamble is a highly diversified products consumer goods company with a large global presence. The company generates 57% of its revenue from overseas.

Procter & Gamble has a history of increasing dividends for the last 55 years and has also been adding value to shareholders through share repurchases.

Procter & Gamble is the industry leader in innovation of new products and innovation in product improvements. The company invests more in R&D than any of its competitors. It also has the strongest portfolio of brands in consumer nondurables.

Procter & Gamble has a strong presence and a clear focus to grow in emerging markets where there is great growth potential. Higher growth in GDP, population and disposable income in other countries other than the US will be the driver of revenue growth.

INVESTMENT NEGATIVES

Increase in commodity prices can affect the company’s profit margins because in the current competitive market it is difficult to pass price increases to the consumer.

Strengthening of the dollar will affect the company’s revenues as 57% of the revenues come from the overseas market. The recent strengthening of the

affect the company’s revenues as 57% of the revenues come from the overseas market. The recent

9

Henry Fund Research

THE UNIVERSITY OF IOWA

Henry B. Tippie School of Management

dollar against Euro will affect the revenue in the coming quarters.

If the current trend of trading down to lower-prices private label products continue, Procter & Gamble’s future revenue growth will be affected.

VALUATION

Our estimated price of Procter & Gamble’s share using DCF and EP is $89.60 .Using relative P/E ratio, the price is $62.25 and using Dividend Discount Model the price is $70.32. By taking the average valuations of the different models our target price is $74.05. Given this valuation and the qualitative research about the industry and the company, we recommend a Hold recommendation on the stock.

The valuation of share price of Procter & Gamble has been done by assuming a risk-free rate of 4.64%- current 30 year Treasury bond rate. MRP has been taken as 4.5%( Henry Fund Analyst’s consensus). The terminal growth rate is taken as 3% which is reasonable for a company like Procter & Gamble

The valuation is very sensitive to the COGS as a percentage of revenue and SGA as percentage of revenue. Even a 1% change in any of them has a substantial change in the target price. Valuation is also quite sensitive to the Beta which is currently taken as 0.59. The model assumes the WACC of 7.33%.

Sell and Buy discipline

We would consider a Sell on Procter & Gamble if any of the following factors occurs:

Sharp increase in commodity prices that could lead to lower margins.

Any major change in government policies that will affect effective tax rate and environmental regulations.

If management changes its focus from innovation or is unable to create attractive marketing and sales programs.

We would consider Buy recommendation if any of the following factors occurs:

More than expected revenue growth in the future.

If Procter & Gamble lowers the COGS more than is projected in the valuation model or if it reduces SGA below the projected levels.

REFERENCES

1.

 

2.

www.mergentonline.com

3.

P&G Annual report 2009

4.

Company Financials 2003 to 2009

 

5.

P&G Annual report 2008

 

6.

P&G

presentation

at

CAGNY

Conference

Feb2010

 

7.

S&P

Net

Advantage

Industry

surveys-

Household nondurables

 

8.

US Bureau of Economic analysis

 

9.

10.

11.

 

12.

US Department of Commerce statistics

IMPORTANT DISCLAIMER

This report was created by a student(s) enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa’s Tippie School of Management. The intent of these reports is to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.

Procter & Gamble Co. Year ending June 30 ( Figures in millions)

Revenue by business segment

2007

2008

2009

2010E

2011E

2012E

2013E

CV

Beauty

17889

19515

18789

19353

19933

20531

21147

21782

Grooming

7437

8254

7543

7845

8237

8649

9081

9535

Beauty GBU

25326

27769

26332

27197

28170

29180

30228

31317

 

9.6%

-5.2%

3.3%

3.6%

3.6%

3.6%

3.6%

Health care Snack and Pet Care

13381

14578

13623

14168

14735

15324

15937

16574

2985

3204

3114

3207

3304

3403

3505

3610

Health care and well-being GBU

16366

17782

16737

17375

18038

18727

19442

20184

 

8.7%

-5.9%

3.8%

3.8%

3.8%

3.8%

3.8%

Fabric Care and Home Care Baby Care and Family Care

21355

23714

23186

24113

25319

26585

27914

29310

12726

13898

14103

14808

15697

16638

17637

18695

Household care GBU

34081

37612

37289

38922

41016

43224

45551

48005

 

10.4%

-0.9%

4.4%

5.4%

5.4%

5.4%

5.4%

Corporate

-941

-1415

-1329

-1357

-1395

-1442

-1501

-1573

Net Sales

76,476

83,503

79029

82137

85829

89688

93720

97933

 

9.2%

-5.4%

3.9%

4.5%

4.5%

4.5%

4.5%

Procter & Gamble Co. Year ending June 30 ( Figures in millions)

As Reported Annual Income Statement

2007

2008

2009

2010E

2011E

2012E

2013E

CV

Net sales Cost of products sold Selling, general & administrative expense

76,476

83,503

79,029

82052

85190

88641

92629

96798

36,686

40,695

38,898

38798

40908

42782

44935

46814

24,340

25,725

24,008

24673

26277

27396

28715

30457

Operating income (loss) Interest expense Other non-operating income (expense), net Earnings (loss) before income taxes Total current provision (benefit) for income taxes Total deferred income tax provisions (benefits) Income taxes

15,450

17,083

16,123

18581

18005

18462

18980

19526

1,304

1,467

1,358

2144

1944

1946

1996

2068

564

462

560

143

90

106

143

157

14,710

16,078

15,325

16580

16151

16622

17127

17615

4,117

2,789

3,436

253

1,214

596

4,370

4,003

4,032

4360

4248

4372

4504

4633

Net earnings (loss)

10,340

12,075

13,436

12219

11904

12250

12622

12982

Preferred dividends, net of tax benefit

161

176

192

202

212

222

233

245

Net earnings (loss) to common

10,179

11,899

13,244

12018

11692

12028

12389

12737

Weighted average shares outstanding-basic Net earnings (loss) per share-basic Dividends per common share Dividend Payout Ratio

3,159

3,080.80

2,952.20

2922

2897

2876

2848

2825

3.22

3.86

4.49

4.11

4.04

4.18

4.35

4.51

1.28

1.45

1.64

1.80

1.98

2.18

2.40

2.64

40%

38%

37%

44%

49%

52%

55%

59%

Procter & Gamble Co. Year ending June 30 ( Figures in millions)

Annual Balance Sheet

2007

2008

2009

2010E

2011E

2012E

2013E

CV

Assets

 

Current Assets Cash & cash equivalents Investment securities Accounts receivable Total inventories Deferred income taxes Prepaid expenses & other current assets

5,354

3,313

4,781

2,392

2,883

4,108

4,546

4,914

202

228

615

639

665

695

726

6,629

6,761

5,836

6,564

6,679

6,914

7,188

7,512

6,819

8,416

6,880

7,392

7,597

7,824

8,092

8,368

1,727

2,012

1,209

1,641

1,704

1,773

1,853

1,936

3,300

3,785

3,199

3,364

3,493

3,634

3,798

3,969

Total current assets

24,031

24,515

21,905

21,969

22,995

24,918

26,171

27,425

Long Term Assets Total property, plant & equipment Accumulated depreciation

34,721

38,086

36,651

41,292

44,899

48,569

52,490

56,466

15,181

17,446

17,189

19,719

22,524

25,432

28,440

31,567

Net property, plant & equipment Goodwill Trademark & other intangible assets, net

19,540

20,640

19,462

21,573

22,375

23,136

24,050

24,899

56,552

59,767

56,512

58,747

60,509

62,324

64,194

66,120

33,626

34,233

32,606

34,881

34,036

37,005

38,115

39,259

Net goodwill & other intangible assets Other non-current assets

90,178

94,000

89,118

91,792

94,545

97,382

100,303

103,312

4,265

4,837

4,348

4,513

4,685

4,875

5,095

5,324

Total assets

138,014

143,992

134,833

139,847

144,601

150,311

155,618

160,960

Liabilities & Shareholder Equity

 

Current Liabilities Accounts payable Taxes payable Accrued & other liabilities Debt due within one year

5,710

6,775

5,980

6,564

6,815

7,091

7,410

7,744

3,382

945

722

1,641

1,704

1,773

1,853

1,936

9,586

10,154

8,601

9,846

10,223

10,637

11,116

11,616

12,039

13,084

16,320

9,243

8,378

8,388

8,604

8,915

Total current liabilities

30,717

30,958

30,901

27,294

27,120

27,889

28,982

30,210

Long Term Liabilities Long-term debt Deferred income taxes Other non-current liabilities

23,375

23,581

20,652

24,270

25,172

26,028

27,056

28,011

12,015

11,805

10,752

11,487

11,927

12,410

12,968

13,552

5,147

8,154

9,427

9,846

10,223

10,637

11,116

11,616

Total liabilities

71,254

74,498

71,734

72,898

74,442

76,963

80,122

83,389

Shareholder Equity Preferred stock Total Common Stock and Paid-in Capital Reserve for ESOP debt retirement Accumulated other comprehensive income (loss) Treasury stock, at cost Retained earnings (accumulated deficit)

1,406

1,366

1,324

1,324

1,324

1,324

1,324

1,324

63,020

64,309

65,125

67,283

69,598

72,083

74,748

77,608

1,308

1,325

1,340

1,340

1,340

1,340

1,340

1,340

617

3,746

(3,358)

(3,358)

(3,358)

(3,358)

(3,358)

(3,358)

38,772

47,588

55,961

60,961

65,961

70,961

76,961

82,961

41,797

48,986

57,309

64,001

69,895

75,600

81,083

86,297

Total shareholders' equity (deficit)

66,760

69,494

63,099

66,949

70,158

73,348

75,496

77,570

Total Liabilities and Shareholder equity

138,014

143,992

134,833

139,847

144,600

150,311

155,618

160,960

Procter & Gamble Co. Year ending June 30 ( Figures in millions)

As Reported Annual Cash Flow

2007

2008

2009

Cash & cash equivalents, beginning of year

6,693

5,354

3,313

Cash from Operations

 

Net earnings (loss) Depreciation & amortization Share based compensation expense Deferred income taxes Loss (gain) on sale of business Accounts receivable Inventories Accounts payable, accrued & other liabilities Other operating assets & liabilities Other operating activities

 

10,340

12,075

13,436

3,130

3,166

3,082

668

555

516

253

1,214

596

-

-

-2,377

 

-729

432

415

-389

-1,050

721

-273

134

-742

-157

-1,239

-758

592

527

30

Net cash flows from operating activities

13,435

15,814

14,919

Cash from Investing

 

Capital expenditures Proceeds from asset sales Acquisitions, net of cash acquired Change in investment securities

 

-2,945

-3,046

-3,238

281

928

1,087

-492

-381

-368

673

-50

166

Net cash flows from investing activities

-2,483

-2,549

-2,353

Cash from Financing

 

Dividends to shareholders Change in short-term debt Additions to long-term debt Reductions of long-term debt Impact of stock options & other Treasury stock purchases Impact of stcok options & other financing activities

 

-4,209

-4,655

-5,044

8,981

1,844

-2,420

4,758

7,088

4,926

-17,929

-11,747

-2,587

1,499

1,867 -

-5,578

-10,047

-6,370

-

-

681

Net cash flows from financing activities

-12,478

-15,650

-10,814

Effect of exchange rate changes on cash & cash equivalents Change in cash & cash equivalents

 

187

344

-284

-1,339

-2,041

1,468

Cash & cash equivalents, end of year

5,354

3,313

4,781

Procter & Gamble Co. Year ending June 30 ( Figures in millions)

Projected Annual Cash Flow

2010

2011

2012

2013

2014

Cash & cash equivalents, beginning of year

4,781

2,392

2,883

4,108

4,546

Operating Activities

 

Net earnings (loss) Depreciation Amortization of intangables Deferred income taxes Accounts receivable Inventories Change in Prepaid expenses and other current assets Change in Accounts Payable Change in Taxes Payable Change in Accrued and other Liabilities Change in other non current liabilities Change in other non current assets

12018

11692

12028

12389

12737

2530

2805

2909

3008

3126

620

663

647

703

724

303

377

414

479

500

-728

-115

-235

-274

-323

-512

-205

-227

-268

-276

-165

-129

-141

-164

-171

584

251

276

319

333

919

63

69

80

83

1,245

377

414

479

500

419

377

414

479

500

-165

-173

Net cash flow from Operating Activities

17,788

15,959

16,351

16,980

17,474

Cash from Investing

 

Capital expenditures Change in investment securities Acquisitions, net of cash required

-3,282

-3,408

-3,546

-3,705

-3,872

-615

-24

-26

-30

-31

-4,652

-3,616

-3,607

-3,841

-3,837

Net cash flow from Investing acticities

-8,550

-7,023

-7,153

-7,546

-7,709

Cash fromFinancing

 

Dividends to shareholders Change in short term debt Change in long term debt Proceeds from Stock option Treasury stock purchases

-5,326

-5,798

-6,323

-6,907

-7,523

-7,077

-865

9

216

311

3,618

902

856

1,028

955

2,158

2,315

2,484

2,666

2,860

-5,000

-5,000

-5,000

-6,000

-6,000

Net Cash flow from Financing Activities

-11,627

-8,445

-7,973

-8,997

-9,396

Change in cash & cash equivalents

-2,389

491

1,225

437

369

Cash & cash equivalents, end of year

2,392

2,883

4,108

4,546

4,914

Procter & Gamble Co.

Common Size Income Statement

2007

2008

2009

2010E

2011E

2012E

2013E

CV

Net sales Cost of products sold Selling, general & administrative expense

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

47.97%

48.73%

49.22%

47.29%

48.02%

48.27%

48.51%

48.36%

31.83%

30.81%

30.38%

30.07%

30.85%

30.91%

31.00%

31.47%

Operating income (loss) Interest expense Other non-operating income (expense), net Earnings (loss) before income taxes Total current provision (benefit) for income taxes Total deferred income tax provisions (benefits) Income taxes

20.20%

20.46%

20.40%

22.65%

21.14%

20.83%

20.49%

20.17%

1.71%

1.76%

1.72%

2.61%

2.28%

2.20%

2.15%

2.14%

0.74%

0.55%

0.71%

0.17%

0.11%

0.12%

0.15%

0.16%

19.23%

19.25%

19.39%

20.21%

18.96%

18.75%

18.49%

18.20%

5.38%

3.34%

4.35%

0.00%

0.00%

0.00%

0.00%

0.00%

0.33%

1.45%

0.75%

0.00%

0.00%

0.00%

0.00%

0.00%

5.71%

4.79%

5.10%

5.31%

4.99%

4.93%

4.86%

4.79%

Net earnings (loss)

13.52%

14.46%

17.00%

14.89%

13.97%

13.82%

13.63%

13.41%

Procter & Gamble Co.

Annual Balance Sheet-Common size

2007

2008

2009

2010E

2011E

2012E

2013E

CV

Assets

 

Current Assets Cash & cash equivalents Investment securities Accounts receivable Total inventories Deferred income taxes Prepaid expenses & other current assets

3.88%

2.30%

3.55%

1.71%

1.99%

2.73%

2.92%

3.05%

0.15%

0.16%

0.00%

0.44%

0.44%

0.44%

0.45%

0.45%

4.80%

4.70%

4.33%

4.69%

4.62%

4.60%

4.62%

4.67%

4.94%

5.84%

5.10%

5.29%

5.25%

5.21%

5.20%

5.20%

1.25%

1.40%

0.90%

1.17%

1.18%

1.18%

1.19%

1.20%

2.39%

2.63%

2.37%

2.41%

2.42%

2.42%

2.44%

2.47%

Total current assets

17.41%

17.03%

16.25%

15.71%

15.90%

16.58%

16.82%

17.04%

Long Term Assets Total property, plant & equipment Accumulated depreciation

25.16%

26.45%

27.18%

29.53%

31.05%

32.31%

33.73%

35.08%

11.00%

12.12%

12.75%

14.10%

15.58%

16.92%

18.28%

19.61%

Net property, plant & equipment Goodwill Trademark & other intangible assets, net

14.16%

14.33%

14.43%

15.43%

15.47%

15.39%

15.45%

15.47%

40.98%

41.51%

41.91%

42.01%

41.85%

41.46%

41.25%

41.08%

24.36%

23.77%

24.18%

24.94%

23.54%

24.62%

24.49%

24.39%

Net goodwill & other intangible assets Other non-current assets

65.34%

65.28%

66.10%

65.64%

65.38%

64.79%

64.45%

64.19%

3.09%

3.36%

3.22%

3.23%

3.24%

3.24%

3.27%

3.31%

Total assets

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

Liabilities & Shareholder Equity

 

Current Liabilities Accounts payable Taxes payable Accrued & other liabilities Debt due within one year

4.14%

4.71%

4.44%

4.69%

4.71%

4.72%

4.76%

4.81%

2.45%

0.66%

0.54%

1.17%

1.18%

1.18%

1.19%

1.20%

6.95%

7.05%

6.38%

7.04%

7.07%

7.08%

7.14%

7.22%

8.72%

9.09%

12.10%

6.61%

5.79%

5.58%

5.53%

5.54%

Total current liabilities

22.26%

21.50%

22.92%

19.52%

18.76%

18.55%

18.62%

18.77%

Long Term Liabilities Long-term debt Deferred income taxes Other non-current liabilities

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

16.94%

16.38%

15.32%

17.35%

17.41%

17.32%

17.39%

17.40%

8.71%

8.20%

7.97%

8.21%

8.25%

8.26%

8.33%

8.42%

3.73%

5.66%

6.99%

7.04%

7.07%

7.08%

7.14%

7.22%

Total liabilities

51.63%

51.74%

53.20%

52.13%

51.48%

51.20%

51.49%

51.81%

Shareholder Equity Preferred stock Total Common Stock and Paid-in Capital Reserve for ESOP debt retirement Accumulated other comprehensive income (loss) Treasury stock, at cost Retained earnings (accumulated deficit)

1.02%

0.95%

0.98%

0.95%

0.92%

0.88%

0.85%

0.82%

45.66%

44.66%

48.30%

48.11%

48.13%

47.96%

48.03%

48.22%

0.95%

0.92%

0.99%

0.96%

0.93%

0.89%

0.86%

0.83%

0.45%

2.60%

-2.49%

-2.40%

-2.32%

-2.23%

-2.16%

-2.09%

28.09%

33.05%

41.50%

43.59%

45.62%

47.21%

49.46%

51.54%

30.28%

34.02%

42.50%

45.77%

48.34%

50.30%

52.10%

53.61%

Total shareholders' equity (deficit)

48.37%

48.26%

46.80%

47.87%

48.52%

48.80%

48.51%

48.19%

Total Liabilities and Shareholder equity

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

Procter & Gamble Co. Year ending June 30 ( Figures in millions) Value Drivers

NOPLAT

2007

2008

2009

2010E

2011E

2012E

2013E

CV

Income before income taxes(EBT) (+)Interest Expense (-)Non Operating Interest income EBITA Less: Taxes on EBITA Total Income Tax provision (+) Tax shield on interest Exp (-)Tax on non operating Income Total adjusted taxes on EBITA Plus Change in deffered taxes

14,710

16,078

15,325

16,580

16,151

16,622

17,127

17,615

1304

1467

1358

2144

1944

1946

1996

2068

564

462

560

143

90

106

143

157

15,450

17,083

16,123

18,581

18,005

18,462

18,980

19,526

1304

1467

1358

2144

1944

1946

1996

2068

343

386