Stock Valuation Report on Procter & Gamble Company (NYSE: PG) · Procter & Gamble is the world’s...

Stock Valuation Report on Procter &

Gamble Company (NYSE: PG)

FIN129: Student-Managed Investment Fund (SMIF)

Instructor: Dr. K.C. Chen, CFA

Student: Benjamin H. Dadian

Date: December 17, 2019

TABLE OF CONTENTS

One Page Summary…………………………………………………………………………….…1

I. Recommendation: Buy/Sell @? Or Hold……………………………………………..1

II. Investment Positives…………………………………………………………………..1

III. Investment Risks………………………………………………………………………1

Main Stock Report………………………………………………………………………………...2

IV. Overview of Company………………………………………………………………...2

V. Historical Performances……………………………………………………………….3

1. Historical Income Statements and Balance Sheets………………………………..3

2. Common-Size Income Statements and Balance Sheets…………………………...4

a. Purpose of Common-Size Financial Statements………………………………4

b. Discussion of Key Items: sales growth rates, margins, etc……………………4

3. Historical NOPLAT, Invested Capital, ROIC, and Free Cash Flow……………...7

a. Discussion of NOPLAT……………………………………………………….7

b. Discussion of Invested Capital and ROIC…………………………………….8

c. Discussion of FCF…………………………………………………………...10

VI. Computation of Intrinsic Values……………………………………………………..12

1. Valuation Models – DCF Model and Relative Valuation Model………………..12

2. Assumptions……………………………………………………………………...14

a. Sales Growth Rates…………………………………………………………..14

b. Operating Relationships……………………………………………………...14

3. Estimation of WACC…………………………………………………………….16

a. Discussion of Cost of Debt Estimation………………………………………16

b. Discussion of Cost of Equity Estimation, Including Rf, Industry , and market

risk premium, respectively…………………………………………………...16

c. Market-value Weights of Debt and Equity…………………………………..18

d. Computation of WACC……………………………………………………...18

4. Free Cash Flow for 10 Years…………………………………………………….19

5. Computation of Continuing Values – Various Approaches……………………..20

6. Enterprise Values………………………………………………………………...21

7. Intrinsic Values…………………………………………………………………..21

8. Comparison of Intrinsic Values and Market Value per Share…………………...22

9. Sensitivity Analysis……………………………………………………………...22

VII. Conclusion…………………………………………………………………………...23

VIII. References……………………………………………………………………………25

IX. Appendices…………………………………………………………………………...27

Student: Benjamin H. Dadian FIN 129: Student Managed Investment Fund (SMIF)

1Source: https://research.valueline.com/research#sec=company&sym=PG 2Source: https://www.fool.com/investing/2019/12/02/better-buy-procter-gamble-vs-altria.aspx 3Source: https://csimarket.com/stocks/competitionSEG2.php?code=PG 4Source: https://www.fool.com/investing/2019/11/20/is-procter-gamble-stock-a-buy.aspx 5Source: https://www.cnbc.com/2017/07/17/billionaire-activist-blasts-pg-for-letting-online-shave-clubs-obliterate-gillette.html

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ONE PAGE SUMMARY

I. Recommendation: Buy/Sell @? Or Hold

I recommend holding Procter & Gamble at its current price of $109.65 (as of 6/30/19)

II. Investment Positives

Steady dividend yield

Procter & Gamble pays a steady dividend. Over the past three years, they have increased their

dividends by an average of 3%1. This is in keeping with their tradition, as they have raised

dividends annually for 63 years straight2.

Large market share

Procter & Gamble has the leading market share in the following business segments: Fabric &

Home Care (10.52%), Baby, Feminine & Family Care (32.85%), and Beauty (15.48%). This

leading market share in these ultra-competitive segments demonstrate the demand is still there

for this 182-year old’s products3.

Sales growth is increasing

Procter & Gamble finished their 2019 fiscal year with the fastest growth in over 10 years, and

their first quarter in fiscal 2020 came with a 7% increase in sales and an 11% increase in

earnings YoY4.

III. Investment Risks

Long term growth will be low

While in the near-term growth is optimistic, conventional wisdom dictates that any supernormal

long-term growth in this mature of a company is highly unlikely.

High earnings multiple

Procter & Gamble currently trades at around 26x earnings. This seems to be a high multiple for a

mature company with modest growth prospects1.

Highly competitive industry

The consumer goods industry is packed with competitors such as Clorox and Unilever, as well as

startups such as Harry’s and Dollar Shave Club.


1Source: https://www.fool.com/investing/2019/12/02/better-buy-procter-gamble-vs-altria.aspx 2Source: https://www.pgcareers.com/about-us

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MAIN STOCK REPORT

IV. Overview of Company

Procter & Gamble is an American multinational consumer goods corporation that operates in the

five following segments1:

Beauty (20% of Q1 2020 revenue)

Grooming (9%)

Healthcare (12%)

Fabric & Home Care (33%)

Baby, Feminine, & Family Care (26%)

Procter & Gamble is the world’s largest consumer goods company, as they sell their products to

approximately 5 billion consumers in roughly 180 countries, mainly through grocery stores,

merchandisers, drug stores, department stores, specialty stores, e-commerce, and pharmacies.

They sell products under 65 brands which are organized into the following 10 product

categories2:

Fabric Care (Gain, Tide, Downy)

Home Care (Mr. Clean, Swiffer, Dawn)

Baby Care (Pampers, Luvs)

Feminine Care (Always, Tampax)

Family Care (Bounty, Puffs, Charmin)

Grooming (Gillette, Braun, Venus)

Oral Care (Crest, Oral-B)

Personal Health Care (Metamucil, NyQuil, Nasivin)

Hair Care (Head & Shoulders, Rejoice, Pantene)

Skin & Personal Care (Olay, Old Spice, Safeguard)


1Source: https://www.cnbc.com/2017/07/17/billionaire-activist-blasts-pg-for-letting-online-shave-clubs-obliterate-gillette.html 2Source: https://www.fool.com/investing/2019/11/20/is-procter-gamble-stock-a-buy.aspx 3Source: https://www.pgcareers.com/about-us

3

While Procter & Gamble is a giant in the consumer goods sector, they face much competition

from a myriad of established companies, such as Newell Brands, Colgate-Palmolive and Johnson

& Johnson. Battling all of these companies, Procter & Gamble has been able to maintain their

market share in many segments. However, they have faced stiff competition from startups,

specifically in the grooming category. Startups Harry’s and Dollar Shave Club took serious

market share from Procter & Gamble’s Gillette brand (which was acquired in 2005). So serious

of a problem did these startups pose to Gillette that activist investor Nelson Peltz launched a

proxy fight in order to obtain a seat on Procter & Gamble’s board, in which he was ultimately

successful1.

On the strategic front, Procter & Gamble has utilized its already large market presence to assert

its other brands to obtain the top or second from the top spot in its respective category. This

strategic goal has helped drive its growth rate higher than its peers2.

Procter & Gamble invests decently in research and development, committing $2 billion solely for

that purpose each year. In turn, they have 55,000 active patents, top market share among

millennials, and 170 products on the top 25 list since 1995. Perhaps most notably is that they

have $3 billion in e-commerce business, which is the largest of any consumer-packaged goods

companies3.

V. Historical Performances

1. Historical Income Statements and Balance Sheets

The annual income statement and balance sheet for Procter & Gamble for the five years from

2015 to 2019 is analyzed. Earnings per share and shares outstanding data is included as well.

(For the complete income statement and balance sheet, please see Tables 1 and 3 in the

Appendix)


1Source: https://www.fool.com/investing/2019/12/02/better-buy-procter-gamble-vs-altria.aspx 4

2. Common-Size Income Statements and Balance Sheets

a. Purpose of Common-Size Financial Statements

The purpose of common-size financial statements is to show relationships between the line items

and the revenue. We are able to calculate useful metrics this way. It allows us to compare and

contrast different items and relate them all back to one common denominator, the overall

revenue. These ratios and margins can offer a starting point to determine whether there are any

red flags and what areas you need more information in. (For the complete common-size income

statement, statement of cash flows, and balance sheet, please see Tables 1, 2 and 3 in the

Appendix)

b. Discussion of Key Items

Sales Growth Rates

Sales growth rates are simply the measure of the increase or decrease in sales from year to year.

These growth rates are calculated using the following formula:

Sales growth rate=(sales1/sales0)-1

Procter & Gamble’s average sales growth rate over the five years analyzed was -2.69%.

However, this average is not an accurate view of the yearly changes, as they were in actuality

much more volatile. Sales growth in 2016 and 2017 were negative, at -14.39% and -0.37%. In

2018 and 2019, they experienced positive growth, as sales increased 2.73% and 1.27%.

There are always many factors that affect a company’s sales. In the case of Procter & Gamble,

the stock tends to trade similarly to that of the broader market. In 2016, the year in which Procter

& Gamble’s sales fell by 14%, the overall market fell as well, as oil prices plunged from above

$100 a barrel to below $30 a barrel. Additionally, Procter & Gamble tends to suffer from the

stronger dollar, as it eats up foreign sales1. The dollar rose throughout 2016 before coming down

in the beginning of 2017. However, it was also in 2017 that activist investor Nelson Peltz

1Source: https://www.ft.com/content/33455430-b210-11e9-bec9-fdcab53d6959

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announced a large stake in the company and wagered a proxy fight to obtain a seat on the board

of directors. After he claimed his seat, he helped implement cost cutting and encouraged more

innovation. It seemed a turnaround had begun, as revenue growth has trended higher since1.

Gross Profit Margin

Gross profit margin is the percentage of revenues left over after subtracting the correlating cost

of goods sold. This is pictured in the following formula:

Gross profit margin = (sales – cost of goods sold) / sales

Procter & Gamble’s gross profit margin has stayed steady at around 50% for the five years

analyzed. This is encouraging, as their costs of goods sold is demonstrated to stay in line with

fluctuations in their revenues. A decent gross profit margin is vital in order to generate positive

operating and net profit margins, which show whether the company is actually making any

money after all expenses.

Operating Profit Margin

The operating profit margin is the percentage of revenues left over after subtracting out all

necessary expenses to keep the company up and running. It is found by dividing the operating

profit by the total sales. Operating profit is found by taking the total sales and subtracting out the

cost of goods sold, operating expenses, depreciation and amortization. This is pictured in the

following formula:

Operating profit margin = (sales - cost of goods sold - operating expenses - depreciation &

amortization) / sales

Procter & Gamble’s operating profit margin rose from 18% in 2015 to 21% in 2016-2018, and

then to 20% in 2019. The slight margin increase was mainly due to a small decrease in selling,

general and administrative expenses, as well as the small increase in revenues touched upon

previously


1Source: https://www.investopedia.com/terms/o/operating_profit.asp 2Source: 2019 Procter & Gamble 10-K 3Source: https://www.cnbc.com/2019/07/30/procter-gamble-writes-down-gillette-business-but-remains-confident-in-its-future.html

6

The operating profit margin shows the core profitability of the company, as it includes every

expense that is needed to keep the business running. This is why operating profit includes asset-

related depreciation and amortization, as these are a result of a firms operations1.

Operating profit is often referred to as EBIT, which stands for earnings before interest and tax.

However, EBIT takes into account a company’s non-operating income and expenses, but the

theory behind looking at these metrics is still the same. Operating profit and EBIT both offer a

view of the company’s ability to generate profit regardless of their capital structure. A firm’s

capital structure is how it finances itself, by raising money through debt (i.e. commercial paper

or long-term bonds) or equity offerings (i.e. initial public offerings or seasoned equity offerings).

As a general rule, debt financing is cheaper than equity financing.

Net Profit Margin

Net profit margin is the percentage of total profit left after subtracting out all expenses. It is the

bottom line of the income statement, as it takes into account every cash and non-cash expense

the firm incurs. It shows whether management is able to generate enough revenue to cover both

direct and indirect (overhead) expenses. Net profit margin is found using the following formula:

Net profit margin = (sales-cost of goods sold-operating and other expenses-interest-taxes) / sales

Procter & Gamble’s net profit margin shows some volatility from 2015-2019. From a 9% net

profit margin in 2015, it increased to 16% in 2016, 24% in 2017, back down to 15% in 2018, and

even lower to 6% in 2019. According to Procter & Gamble management, the unusually low net

profit margin is “due to the after-tax impact of the Shave Care impairment.”2 As previously

mentioned, Procter & Gamble has faced fierce competition from startup grooming companies,

and this forced them to take an impairment charge of $8 billion in fiscal Q4 2019, which resulted

in a net loss of $5.24 billion respective to the carrying values of Gillette’s goodwill and

intangible assets3. Still, on the conference call announcing the impairment charge, CFO Jon


*EBITA is used instead of EBIT because unlike physical assets, organic investment in intangibles are expensed instead of capitalized, so when the acquired intangible loses value and is replaced through more investment, the reinvestment has already been expensed, and the company is charged twice: one through amortization and a second time through reinvestment (Keller, Goedhart & Wessels, 187) 1Source: Valuation: Measuring and Managing the Value of Companies

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Moeller stated that “grooming continues to be a very attractive business,” and that organic sales

are up on a year over year basis.

It is important to compare this net profit margin to the operating profit margin, because while

Procter & Gamble’s net profit took a large dip from the write down, its operating profit was

seemingly unaffected. This is because the write down was a one-time non-cash expense and

unrelated to the actual operations of the company.

3. Historical NOPLAT, Invested Capital, ROIC, and Free Cash Flow

In order to accurately analyze a company’s operating performance, it is essential to reorganize

the financial statements to get a full and clearer picture. We have reorganized Procter &

Gamble’s financial statements to calculate and analyze their historical NOPLAT, Invested

Capital, ROIC, and Free Cash Flow. These reorganized financial statements are available in full

in Tables 5, 6, 7, and 8 of the Appendix, respectively.

a. Discussion of NOPLAT

Net operating profit less adjusted taxes, known as NOPLAT, represents the profits generated

from a company’s core operations after subtracting the income taxes related to the core

operations. In general, a company’s profit is available to three owners: the government, debt

holders, and equity owners. NOPLAT is the profit available to both debt holders and equity

owners after paying the government their share. It excludes all income from nonoperating assets

or financing expenses1. In Appendix Table 5, it shows the NOPLAT calculation to be (EBIT +

amortization – operating cash taxes). Adding amortization to EBIT gives us the adjusted

EBITA*, or earnings before interest, taxes and amortization. However, Procter & Gamble’s

financial statements do not separate depreciation expense from amortization. Therefore, we


1Source: Valuation: Measuring and Managing the Value of Companies 8

assumed the entire “depreciation & amortization” expense line item to be entirely depreciation.

So, our NOPLAT calculation can be simplified to the following formula:

NOPLAT = EBIT * (1-tax)

Also on Appendix Table 5 is the calculation of the operating taxes on EBITA. This is found by

first calculating the taxes on EBITA, in which we add the reported taxes from the income

statement to the tax shield on the interest paid, and then subtract the taxes on interest received.

The taxes on EBITA are then added to the increase or decrease in deferred taxes assets and

liabilities (which are commonly caused by warranty expense and varying depreciation

schedules).

Lastly on Appendix Table 5 is NOPLAT’s reconciliation to net income. It is vital that NOPLAT

is calculated correctly, as the return on invested capital (ROIC) and free cash flow calculations,

which are discussed next, stem from our NOPLAT calculation.

Procter & Gamble’s NOPLAT was positive for all four years analyzed, with a substantial

increase from $9.5 billion to $11.2 billion in 2016-2017, an even larger decrease to $8.2 billion

in 2018, and finally about a 30% increase to $10.8 billion in2019, which accounts for an overall

growth of 13% from 2016-2019.

b. Discussion of Invested Capital and ROIC

Invested capital (IC) is the total amount the company has invested in its core operations – mainly

property, plant and equipment and working capital. From a financing perspective, total funds

invested equals debt and its equivalents plus equity and its equivalents. From an investing

perspective, total funds invested equals invested capital plus nonoperating assets1.

Invested capital was calculated two different ways, in order to reconcile one with the other. The

first calculation was the sum of the operating invested capital, short-term investments and equity



investments. The second calculation was made by adding the interest-bearing debt to the equity

and equity equivalents. A complete breakdown of these line items is shown in Appendix Table 6.

Procter & Gamble’s invested capital steadily decreased from $110 billion in 2015 to $94 billion

in 2019. In the first model, the decrease is mainly due to the decrease in operating working

capital. In the second model, the decrease is largely due to the decrease in deferred income taxes,

retained earnings, and treasury stock. While it is commonly said that a firm must spend money to

make money, we should only hope the firm invests its capital on projects with returns above the

WACC. From a general point of view, it raises eyebrows that Procter & Gamble has been

decreasing its invested capital each year. A further probe might consist of discussions with the

management.

Now that NOPLAT and IC have been calculated, we are able to calculate the return on invested

capital (ROIC). ROIC is the return the firm makes on every dollar invested into the business.

It is easily calculated by the following formula:

ROIC1 = NOPLAT1 / IC0

Koller, Goedhart and Wessel also offer the following ROIC formula which highlights per unit

costs. This is because “if a firm has a competitive advantage, it earns a higher ROIC, as it either

charges a price premium or produces its products more efficiently (at lower cost or lower capital

per unit or both)”1. Their formula is as follows:

ROIC = (1 – tax rate) * ((price per unit – cost per unit)/ invested capital per unit)

ROIC is one of the main value drivers for a firm. A higher ROIC is always more favorable. By

comparing ROIC to the firm’s WACC, one is able to quickly tell how much (or how little) value

the firm is creating or destroying.

While Procter & Gamble has faced competition on some fronts, they still hold high market share

in multiple business segments, which has allowed their ROIC to trend up, with only one hiccup



along the way. Their ROIC increased from 9.5% in 2016 to 11.9% in 2017, decreased to 9% in

2018, and then increased substantially to 12.1% in 2019. Their ROIC chart, along with

EV/EBITDA multiples, is shown in Table 7 of the Appendix.

c. Discussion of Free Cash Flow

Free cash flow is the cash flow available to all investors, both debt and equity owners, after

taxes. FCF is independent of financing and nonoperating items, so it can be thought of as the

after-tax cash flow as if the firm held only core operating assets and financed itself solely with

equity. Like ROIC, FCF is calculated from NOPLAT and IC. Free cash flow can be calculated

using the following formulas1:

FCF = NOPLAT + noncash operating expenses – investment in invested capital

FCF = NOPLAT – net increase in invested capital

Additionally, free cash flow can be calculated by subtracting the gross investment from the gross

cash flow. Gross investment is segmented in 5 main areas1:

Change in operating working capital

Net capital expenditures

Change in capitalized operating leases

Investment in goodwill and acquired intangibles

Change in other long-term operating assets, net of long-term liabilities

Cash flow is king, and “anything that doesn’t increase cash flows doesn’t create value.”1 Cash

flow is driven by the expected return on invested capital and revenue growth. These three factors

(FCF, revenue growth, and ROIC) are the value drivers for a firm. Later, we will discount the

free cash flows using WACC to find a value for the firm.


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Once a firm generates FCF, there are generally four ways to deploy it. To maintain and grow

operations, a firm must reinvest at least some of their gross cash flow back into the business.

They can do this by using the FCF to:

Service debt

Invest (in existing operations or by acquiring other businesses)

Pay dividends and/or buyback stock

Increase the asset base

Procter & Gamble’s cash flows available to investors was calculated two different ways and then

reconciled to one another. Because our spreadsheet is set up differently, our fist calculation adds

the gross investment to the gross cash flow to arrive at free cash flow. This free cash flow is

added to after-tax interest received, the increase or decrease in short-term investments, the

increase or decrease in equity investments, and discontinued operations. Our second calculation

takes the sum of the cash flows to debt holders and adds them to the cash flows to the equity

holders to arrive at the cash flows available to investors. The breakdown of both of these

calculations can be found in Table 8 in the Appendix.

An investor or manager always wants free cash flow to increase. However, after increasing from

$14.3 billion in 2016 to $19 billion in 2017, Procter & Gamble’s cash flows available to

investors decreased two years in a row. In 2018 they shrunk to $11.6 billion before falling to

$10.9 billion in 2019. While a completely different calculation, Procter & Gamble’s cash flows

available to investors has followed the pattern of their net income. However, the net income has

been much more volatile, as it takes into account noncash expenses, while FCF does not. It is

especially important to make that note, because of the previously mentioned noncash impairment

charge reported in fiscal 2019. While the FCF paints a better picture than the net income trend,

the decreasing FCF is far from ideal.


*WACC is used as the discount rate because shareholders and creditors receive FCF. If only creditors receive FCF, we would have used the cost of debt multiplied by (1-tax). Likewise, if only shareholders receive FCF, the cost of equity would be used. 1Source: Measuring and Managing the Value of Companies

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VI. Computation of Intrinsic Values

1. Valuation Models – DCF Model and Relative Valuation Model

Out of the many different ways to value a company, we have chosen two approaches: an intrinsic

valuation calculation, and a relative valuation calculation. Out of the many different models to

calculate the intrinsic value, we have chosen the Enterprise Discounted Cash Flow (EDCF)

model. For the relative valuation, we have chosen the commonly used price-to-earnings (P/E)

multiple. Both of these models are discussed in further detail in the following sections.

Additionally, the complete valuation analysis and calculations for the two aforementioned

models can be seen in Appendix Tables 9 and 10, respectively.

Enterprise Discounted Cash Flow (EDCF) Model

Essentially, the enterprise DCF calculation is the sum of the forecasted next 10 years of free cash

flow and the free cash flows thereafter into perpetuity all discounted back to the present using the

firm’s weighted average cost of capital (WACC, which is discussed in a later section)*. This

calculation is pictured below:

VO = ∑ 10𝑡−1 (FCFt / (1+ WACC)t) + (CV10 / (WACC10))

Enterprise DCF is popular because it relies solely on the flow of cash in and out of a company, as

opposed to accounting-based earnings. Once the cash flows are calculated, they are discounted

by the weighted average cost of capital. The debt and other nonequity claims on cash flow are

then subtracted form enterprise value to calculate the equity value. The equity value is then

divided by the total shares outstanding, which gives the intrinsic value of a share of stock.

Koller, Goedhart, and Wessels give a summary of this process of valuing a company’s equity

using enterprise DCF1:

1. Value the company’s operating by discounting free cash flow at the weighted average

cost of capital.


*Estimated dividends for 2020 and 2021 were based off of historical dividend payments 1Source: Yahoo Finance 2021 EPS estimate as of 11/26/19 2Source: Based off of Valueline’s estimate as of 6/21/19 3Source: Measuring and Managing the Value of Companies

13

2. Identify and value nonoperating assets. Summing the value of operating and nonoperating

assets gives gross enterprise value.

3. Identify and value all debt and other nonequity claims against the enterprise value.

4. Subtract the value of debt and other nonequity claims from enterprise value to determine

the value of common equity. To estimate value per share, divide equity value by the

number of current shares outstanding.

The specific inputs and assumptions made in the calculations of our EDCF model are discussed

in the next section. That is followed by the actual free cash flows and continuing value we

arrived at, which in turn is followed with the intrinsic value calculations.

Price-to-Earnings (P/E) Multiple

The P/E multiple valuation approach is reliant on earnings. Traditionally, the price-to-earnings

ratio is found from a group of similar companies, generally within the same sector or industry.

The identified firm’s earnings are then multiplied by the group P/E ratio to calculate the fair

value of the specific firm based on how other similar firms are being valued. However, we took a

different approach to using the P/E multiple to calculate a relative intrinsic value. Our calculation

was based on the future earnings per share estimate1, which was multiplied by our projected

long-term average price-to-earnings ratio2. This value was then added to the estimated dividends*

paid in 2020 and 2021, discounted by the cost of equity (to be discussed in a following section).

The very fact that the P/E multiple is based on earnings is its pitfall, as it mixes capital structure

and nonoperating items with expectations of operating performance. Therefore, differences in

financing structure can unjustly calculate a lower intrinsic value of the firm3. Still, the P/E

multiple can be useful to an analyst, as it can serve as a check against his DCF model, whether it

be an EDCF, DEP, APV, etc.


1Source: https://www.fool.com/investing/2019/12/02/better-buy-procter-gamble-vs-altria.aspx 2Source: https://research.valueline.com/research#sec=company&sym=PG

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2. Assumptions

The assumptions outlined in this section are regarding the inputs for the EDCF model, which

calculates the intrinsic value. Sales growth rates, in addition to operating relationship such as

NOPLAT/sales, working capital/sales, and goodwill/sales will all be discussed.

The subsequent assumptions/forecasts are based off of historical trends and information from

from Valueline’s report on Procter & Gamble on June 21, 2019.

a. Sales Growth Rates (Panel B in Table 9)

For such a mature and established company as Procter & Gamble, it is relatively safe to assume

that there will not be any supernormal growth occurring. However, Procter & Gamble’s fiscal

2019 showed their fastest growth in more than 10 years, and they raised their organic sales

growth outlook to 3%-5%1. Likewise, Valueline estimates that Procter & Gamble’s sales growth

rate will be 4.5% until 2022-20242.

Considering the aforementioned estimates and historical trends, we forecasted a 4.5% sales

growth rate in 2020. The rate is then gradually decreased to 1% in 2030 (this is also the growth

rate assumed for the continuing value calculations discussed in a later section). This is a

reasonable growth rate for a firm in Procter & Gamble’s position and is in line with historical

trends shown in Appendix Table 1.

b. Operating Relationships (Panel A in Table 9)

EBIT/Sales, NOPLAT/Sales, and Marginal Tax Rate

The entire EDCF calculation is heavily influenced by the forecasted EBIT/Sales ratio and

marginal tax rate, because they drive the NOPLAT/Sales ratio, and our entire valuation model is

NOPLAT based.


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As touched upon previously, EBIT (or operating income) is dependent upon the sales, cost of

goods sold, and all operating expense. All of these items have remained fairly steady over the

five years 2015-2019 analyzed, as has EBIT. Therefore, we expect the EBIT/Sales ratio to

somewhat straight-line into the future, and gradually decline.

Because of the Trump tax cuts, Procter & Gamble’s marginal tax rate has trended downwards,

and we have forecasted it out at the current 22% rate for the entirety of our 10-year forecast. It

should be noted, however, that this specific assumption may prove to be the most likely to

deviate from our forecast. There is a very high likelihood that the tax rate for corporations such

as Procter & Gamble would increase with the election of a President representing the Democratic

party.

By subtracting out the forecasted taxes from the forecasted EBIT, we are left with our NOPLAT.

In the next section we will discuss the other assumptions that are added or subtracted to

NOPLAT in order to calculate the FCF.

Depreciation/Sales, Working Capital/Sales, Capital Expenditures/Sales, Goodwill/Sales,

Intangibles/Sales, & Other Assets/Sales

Depreciation/sales, CAPEX/ales, goodwill/sales, intangibles/sales, and other assets/sales were all

calculated based off of the 4-5-year historical trends from 2015-2019 in these respective

relationships (the historical trend analysis can be seen in Appendix Table 11). These specific

relationships had decently clear trends, which were continued for a time in the forecasts, and

then slowly decreased in line with the sales growth rates.

The WC/sales historical trend showed a very volatile relationship. Because there was no more

intricate research done into this topic, we used an average of the past movements in this ratio and

slowly decreased it, in line with the other relationships detailed above. We believe using the

historical average will account for yearly swings in the case they continue.


*For outstanding bonds without an explicit YTM, we found another outstanding bond(s) with a similar maturity date, and made logical adjustments to force an estimated YTM 1Source: http://finra-markets.morningstar.com/BondCenter/Results.jsp

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Using our forecasts outlined in the preceding two sections, we are able to calculate the free cash

flow. The complete analysis of the free cash flow calculations and the process of discounting

them is found in a later section.

3. Estimation of WACC

a. Discussion of Cost of Debt Estimation (Appendix Table 13)

In order to calculate Procter & Gamble’s cost of debt, we can look at their outstanding bonds1.

Specifically, we used the simple average yield to maturity (YTM) as the proxy for the firm’s cost

of debt. First, we must gather all of the information about these bonds, including the coupon rate,

maturity date, and yield to maturity*. We then took a simple average of the YTM of all actively

traded outstanding bonds to arrive at 2.36%, to which we added 0.50% to calculate Procter &

Gamble’s projected before-tax cost of debt. Then, we simply multiply our projected before-tax

cost of debt by (1-tax rate). Using the tax rate of 22%, we calculate Procter & Gamble’s after-tax

cost of debt at 2.23% (this calculation can be seen in Appendix Table 9 Panel C).

b. Discussion of Cost of Equity Estimation (Appendix Table 9 Panel C)

We used the following capital asset pricing model (CAPM) to find Procter & Gamble’s cost of

equity (ke):

𝑘 𝑒 = R𝑓 + 𝛽 × (R − R𝑓 )

R𝑓 = Risk-free rate

𝛽 = Industry beta

R − R𝑓 = Expected return of the market – risk-free rate = market risk premium

These three inputs are discussing in the following sections:

1Source: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=billrates 2Source: https://www.cnbc.com/2019/12/11/fed-decision-interest-rates.html 3Source: https://www.investopedia.com/terms/m/marketriskpremium.asp 4Source: Market Risk Premium and Risk-Free Rate used for 69 countries in 2019: a survery

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Risk-Free Rate

The risk-free rate is known to be the yield of a long-term government bond, generally the 10-

year treasury yield. As of December 3, 2019, the U.S. 10-year treasury yield was 1.60%1.

This risk-free rate changes every day, depending upon a myriad of circumstances. While the risk-

free rate we use in our model is a projection, we have limited further insight and knowledge to be

able to forecast the future moves of this rate. However, Federal Reserve Chairman Jerome

Powell, in his speech on December 11, 2019 following their two-day meeting, indicated that

interest rates would stay steady through 20201. While this is no guarantee, it is the best

information we have. Therefore, we have chosen to keep our projection of the risk-free rate at the

current rate of 1.60%.

Market Risk Premium

The market risk premium explains the relationship between returns from an equity market

portfolio and the U.S. treasury bond yield (the risk-free rate). It reflects required returns,

historical returns, and expected returns3. Therefore, it is calculated by subtracting the risk-free

rate from the expected return of the market (R − R𝑓).

We used the average response from a survey of 1,175 finance and economics professors, analysts

and managers of companies from a paper provided to us4. The average response was a projected

market risk premium of 5.6%, which is the number we used in our model.

Industry Beta

The final input necessary to calculate Procter & Gamble’s cost of equity is the industry beta. We

calculated our own data, by running a regression analysis on the beginning-of-month price of

Procter & Gamble for the 5 years from June 1, 2014 to June 1, 2019. The resulting beta

coefficient of 0.4233 is confirmed as significantly different than zero by the given t-stat of 2.93

and P-value of 0.0047. We then divide the beta coefficient by (1+interest bearing debt/market

cap). The interest-bearing debt is calculated by summing the short-term debt, current capital


*Beta was unlevered and relevered using this specific calculation because Procter & Gamble’s total debt ratio for the five years analyzed (2015-2019) was deemed to be stable. If the total debt ratio was unstable, other allowances would have to be made to accurately calculate the industry beta 1Source: Provided by Dr. Chen

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leases, long-term debt, non-current capital leases, pensions and other benefits, and other

liabilities. The market cap (as of June 30, 2019) was $274,645.95 million. Procter & Gamble’s

unlevered beta is then averaged with a competitor’s beta. For this report, we used Clorox’s

unlevered beta of 0.47711, which yields an average unlevered industry beta of 0.4231. Finally, to

calculate our final industry beta, we relever the average industry beta by dividing the average

unlevered industry beta by (1+interest bearing debt/market cap), which yields an industry beta of

0.4852 (See Appendix Table 12)*. This is the beta used in our model to calculate the cost of

equity (Appendix Table 9 Panel C).

After projecting the inputs listed above, we are able to calculate Procter & Gamble’s cost of

equity, using the aforementioned CAPM model, to be 4.32%.

c. Market-Value Weights of Debt and Equity (Appendix Table 9 Panel C)

Calculating the market-value weights of debt and equity is the last piece of necessary

information in order to calculate WACC. By summing the interest-bearing debt (calculated

above) with the market value of equity (calculated by multiplying the stock price of 109.65 as of

6/1/2019 by the shares outstanding of 2,504 million as of 6/30/2019), the enterprise value of the

firm is valued at $314,866.61 million. This equation can then be used to show debt and equity as

a percentage of the EV value: 12.80% and 87.20%, respectively.

d. Computation of WACC (Appendix Table 9 Panel C)

As previously mentioned, we are using the enterprise discounted cash flow model (EDCF) to

calculate Procter & Gamble’s intrinsic value. When using this model, the firm’s WACC is used

as the discount rate to the free cash flows, because they are available to all investors. The

formula used to calculate WACC is as follows:

WACC = (D/V) * kd * (1-T) + (E/V) * ke


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D = Market value of interest-bearing debt

V = Enterprise value (D+E)

Kd = Cost of debt

T = Tax rate

E = Market value of equity

Ke = Cost of equity

By inputting the numbers projected in the previous three section into this formula, we conclude

that Procter & Gamble has a WACC of 4.05%.

4. Free Cash Flows for 10 Years (Appendix Table 9 Panel B)

Using the projections outlined in the previous sections, we are able to forecast Procter &

Gamble’s free cash flow for the 10-year period from 2020-20230. All projected free cash flows

were positive, with the exception of 2020. This is due to the change in net working capital from

($3,889) million to $1,415 million. Besides this anomaly, FCF ranged from $7,500 million to a

high of $17,800 million. As a percentage of sales, FCF stayed between 10% to 20% with the

exception of 2020 once again.

Using WACC as the discount rate for our EDCF model, we are able to calculate the present

value of the cash flows for the explicit 10-year forecast. By summing them together, we get the

PV of FCF from 2020-2030 of $78,499 million.

Because we believe Procter & Gamble’s operations will continue past the 10-year explicit

forecast, we must estimate a continuing value for the firm to account for their later years. This is

the focus of the next section.


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5. Computations of Continuing Values – Various Approaches (Appendix Table 9

Panel C)

The goal of the continuing value (CV) calculation is to accurately project the future growth and

return for the rest of the life of the company past the explicit forecast period (the 10 years from

2020-2030 in our case). Because we are using the EDCF model, the CV aims to measure all cash

flows investors receive after the explicit 10-year period.

The total intrinsic value of the company depends rather heavily on the CV, because it accounts

for so many years. However, the CV is the most difficult to accurately forecast because of the

risk inherent in the future. In order to most accurately estimate the CV, we have used two

different calculations.

The first CV calculation is as follows:

CV10 = [NOPLAT10 * (1+g) * (1-(g/RONIC10))] / (WACC – g)

G = Growth rate in the infinite period

RONIC = Return on new (or incremental) invested capital

The two most important inputs to be estimated for this model are the growth rate of NOPLAT in

the infinite period, and the RONIC in the infinite period. It seems only foolish to say with

confidence that we have accurately predicted what these two variables will be, as we did not do

any forward-looking research into them. Instead, we based our estimates off of historical trends.

Specifically, we used the terminal growth rate of 1.00% we discussed in an earlier section, as this

seems to be a logical assumption for a mature company. Regarding the RONIC, our only

reference point was the historical ROIC trends (see Appendix Table 7) to estimate what we think

the RONIC should look like going forward. We decided on a 7% RONIC, as it is lower than the

four-year historical ROIC of 10.65%, yet still higher than the WACC of 4.05%. As long as the

RONIC is higher than the firm’s WACC, value will be created. This specific model yielded a CV

of $266,772 million.


21

The second CV calculation is as follows:

CV10 = EBITDA10 * (EV/EBITDA)

In this calculation of CV, the input that drives the final value is the projected EV/EBITDA

multiple. Once again, we based the projected future EV/EBITDA multiple from historical trends.

The average EV/EBITDA over the past five years is just over 16%. Because we have no further

information or insight, we made a logical assumption to decrease the ratio slightly to 15.50% for

the infinite period as the firm matures further. This specific model yielded a CV value of

$219,889 million.

6. Enterprise Values (Appendix Table 9 Panel C)

The enterprise value of a firm is found by summing the PV of the FCF with the PV of the CV

and the non-operating assets. In Procter & Gamble’s case, the only non-operating asset we added

in was short-term investments.

Using the first CV method incorporating projected NOPLAT growth and RONIC, we calculated

the firm’s enterprise value to be $351,319 million.

Using the second CV method incorporating the projected EBITDA multiple, we calculated the

firm’s enterprise value to be $304,436 million.

7. Intrinsic Values (Appendix Table 9 Panel C)

The last step in the EDCF model is to put all of the above steps together and calculate the

intrinsic value of the firm. To do this, we subtract the value of debt from the enterprise value we

calculated previously. This leaves us with the total value of equity, which is then divided by the

shares outstanding to arrive at a per-share intrinsic value.


*The inputs and assumptions for the relative valuation model are discussed in section VI under the Relative Valuation headline

22

Using the first CV calculation of forecasting NOPLAT growth and RONIC, we get an intrinsic

share price of 124.21.

Using the second CV calculation of forecasting the EV/EBITDA multiple, we get an intrinsic

share price of 105.48.

8. Comparison of Intrinsic Values and Market Value per Share (Appendix Table 9

Panel C & Table 10)

If a share of stock is selling for more than its intrinsic value, it is said to be overvalued. If it is

selling for less than its intrinsic value, that same share of stock is said to be undervalued. When

comparing our two intrinsic value calculations using the EDCF model, we find that one

calculation shows that at Procter & Gamble’s selling price of 109.65 as of June 30. 219, the stock

was undervalued by 13%. However, our other calculations show that the same stock, selling at

the same price, on the same day, is overvalued by 4%. This difference is because of the way the

continuing value of the stock was calculated in each method (discussed in the previous section

above).

In addition to the two EDCF calculations, we also performed a relative valuation* based off of

Procter & Gamble’s price to earnings ratio. Using the analyst consensus 2021 EPS estimate

along with our long-term average P/E multiple forecast, we calculated an estimated 2021 share

price of 88.91. After accounting for estimated dividends to be paid in 2020 and 2021 and

discounting them back using the firm’s cost of equity, we arrive at an intrinsic share price of

87.47. This relative valuation indicates that Procter & Gamble was overvalued by about 20%

(Based on Procter & Gamble’s stock price of 109.65 on June 30, 2019).

9. Sensitivity Analysis (Appendix Table 14 Panels A and B)

In order to make our model more dynamic, we have included sensitivity analysis on the intrinsic

value calculation using the first CV approach (forecasting NOPLAT growth and RONIC).



Appendix Table 14 Panel A demonstrates the relationship between RONIC, the terminal growth

rate, and the firm’s intrinsic value. As the RONIC and growth rate increase, so does the intrinsic

value. Conversely, as the RONIC and growth decrease, the firm’s intrinsic value decreases as

well. This is called having a direct relationship.

Appendix Table 14 Panel B demonstrates the relationship between the market risk premium,

terminal growth rate, and the firm’s intrinsic value. As the market risk premium decreases, the

firm’s intrinsic value increases. This is called having an inverse relationship. (Please see the

paragraph directly above for the relationship between the terminal growth rate and the firm’s

intrinsic value)

VII. Conclusion

As shown above, our three different valuation calculations yielded three different intrinsic

values. The EDCF model incorporating the CV value based on projected NOPLAT growth and

RONIC indicated that Procter & Gamble was undervalued by 13% as of June 30, 2019.

However, the EDCF model incorporating the CV value based on the projected EV/EBITDA

multiple indicated that Procter & Gamble was overvalued by 4% as of the same date. Similarly,

the relative valuation model based on Procter & Gamble’s projected P/E multiple also indicated

that the company was overvalued on that date, by about 20%.

The difference in these estimates is accounted for by the limited amount of information we have

gathered about the future prospects of Procter & Gamble, as we made assumptions from a

backward-looking perspective about what we thought could logically happen in the future.

Out of the three models we used, I believe the EDCF model incorporating the CV based on

projected NOPLAT growth and RONIC should yield the most accurate intrinsic value if, and

only if, we have information we are able to confidently forecast these variables on. This is

because this continuing value calculation is based off of main value drivers, the growth and

RONIC specifically. Because we are looking to value the company, it only makes sense to look

at what will influence that valuation. As Koller, Goedhart and Wessels put it, “the combination


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of growth and return on invested capital (ROIC), relative to its cost, is what drives value.”1

However, we do not have information we feel allows us to accurately forecast the NOPLAT

growth and RONIC. While the EDCF model that incorporates the EV/EBITDA multiple is a

vaguer way of calculating the actual value the firm will bring to investors, we are more confidant

in the assumptions made in projecting that variable. Additionally, we believe the EDCF model

incorporating the CV based on projected EV/EBITDA yields a more accurate intrinsic value for

a few different reasons. Firstly, the EDCF model is cash flow based, while the P/E multiple

model is earnings based. Additionally, the EV/EBITDA multiple values the entire firm

(enterprise value), while the P/E multiple values only the equity available to investors.

In conclusion, for the reasons stated above, we believe the EDCF model using CV calculation

that incorporates the EV/EBITDA multiple yields the most accurate valuation of Procter &

Gamble at 105.48/share. Therefore, based off of the closing share price on June 30, 2019 of

109.65, we recommend holding the stock.


25

VIII. References

Bonds. (n.d.). Retrieved from http://finra-markets.morningstar.com/BondCenter/Results.jsp.

Chen, J. (2019, November 18). Operating Profit. Retrieved from

https://www.investopedia.com/terms/o/operating_profit.asp.

Chen, J. (2019, November 18). Market Risk Premium. Retrieved from

https://www.investopedia.com/terms/m/marketriskpremium.asp.

Cox, J. (2019, December 11). Fed Decision: Interest rates left unchanged, indicates no changes

through 2020. Retrieved from https://www.cnbc.com/2019/12/11/fed-decision-interest-

rates.html.

Duprey, R. (2019, November 20). Is Procter & Gamble Stock a Buy? Retrieved from

https://www.fool.com/investing/2019/11/20/is-procter-gamble-stock-a-buy.aspx.

Fernandez, P., Martinez, M., & Acin, I. F. (2019, April 18). Market Risk Premium and Risk-Free

Rate Used for 69 Countries in 2019: A Survey. Retrieved from

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3358901.

Gray, A. (2019, July 30). P&G sales rise by most in 13 years as turnround takes hold. Retrieved

from https://www.ft.com/content/33455430-b210-11e9-bec9-fdcab53d6959.

Lovelace, B. (2017, July 17). Billionaire activist blasts P&G for letting online shave clubs obliterate

Gillette. Retrieved from https://www.cnbc.com/2017/07/17/billionaire-activist-blasts-pg-for-

letting-online-shave-clubs-obliterate-gillette.html.

Lucas, A. (2019, July 30). Procter & Gamble writes down Gillette business but remains confident in

its future. Retrieved from https://www.cnbc.com/2019/07/30/procter-gamble-writes-down-

gillette-business-but-remains-confident-in-its-future.html


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PG's Competition by Segment and its Market Share. (n.d.). Retrieved from

https://csimarket.com/stocks/competitionSEG2.php?code=PG.

Sun, L. (2019, December 2). Better Buy: Procter & Gamble vs. Altria. Retrieved from

https://www.fool.com/investing/2019/12/02/better-buy-procter-gamble-vs-altria.aspx.

U.S. Department of the Treasury. (2019, December 13). Retrieved from

https://www.treasury.gov/resource-center/data-chart-center/interest-

rates/Pages/TextView.aspx?data=billrates.

Value Line - Research - Browse Research. (n.d.). Retrieved from

https://research.valueline.com/research#sec=company&sym=PG.

Wiley. (2015). Wiley Finance: Valuation: Measuring and Managing the Value of Companies,

University Edition (6th Edition).

P&G. (n.d.). Retrieved from http://www.pginvestor.com/Company-

Strategy/Index?KeyGenPage=208821.


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IX. Appendices

Table 1: Procter & Gamble’s Income Statements and Common-Size Analysis from 2015-2019

Table 2: Procter & Gamble’s Statement of Cash Flows and Common-Size Analysis from 2015-

2019


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Table 3: Procter & Gamble’s Balance Sheet and Common-Size Analysis from 2015-2019

Table 4: EDCF Model Inputs from 2015-2019


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Table 5: Procter & Gamble’s NOPLAT from 2016-2019

Table 6: Procter & Gamble’s Invested Capital (IC) from 2015-2019


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Table 7: Procter & Gamble’s ROIC and EV/EBITDA Multiple from 2010 to 2014

Table 8: Procter & Gamble’s Free Cash Flows from 2016-2019


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Table 9: Spreadsheet Valuation of Procter & Gamble Stock (EDCF)

Table 10: Relative Valuation of Procter & Gamble’s Common Stock


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Table 11: Historical Trends & Relationships

Table 12: Beta Calculation


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Table 13: Calculation of Procter & Gamble’s Cost of Debt


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Table 14: Sensitivity Analysis

Panel A

Panel B

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