Procter and Gamble (NYSE:PG)

Discount Cash Flow Analysis Report

Santa Clara University - Leavey School of Business

Professor Ning Pu
By:
Alex Belkeir, Andre Cutrim, Yan Dichev and Ryan Ebner

Table of Contents
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1. Executive Summary__________________________________________________________2

2. Introduction_________________________________________________________________3

3. Data Sources________________________________________________________________4

4. Methodology________________________________________________________________5

5. DCF Analysis_______________________________________________________________5
a. Introduction
b. Sales and Financial Ratios
c. Pro Forma Model
d. WACC
e. Unlevered Free Cash Flow
f. Terminal Value
g. Implied Equity Value per Share
h. Sensitivity Analysis

6. Conclusion and Recommendation______________________________________________17

7. Exhibits___________________________________________________________________18

8. Works Cited_______________________________________________________________28
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1. Executive Summary:

This report is a Discounted Cash Flow Analysis (DCF) of Procter and Gamble (NYSE:

PG). The report uses data from CRSP, FINRA, Compustat, and SEC Edgar. The report evaluates

the company at the end of the 2019 fiscal year (June 30th, 2019) using historical data from 2010

to 2019 and forecasting forward to 2025. A DCF model projects unlevered free cash flow and a

terminal value using assumptions on sales and other factors. Cash flows and the terminal value

are discounted back to the present value using the company’s Weighted Average Cost of Capital

(WACC). This calculates the enterprise value of the company which is used to compute the price

per share.

Using CRSP’s data we were to find the cost of equity and using FINRA’s data we found

the cost of the debt. By combining the two we came to our WACC value of 5.67%. We used a

long-term growth percentage of 2.5 as this is roughly the industry growth rate. We then

computed our future cash flows by making several assumptions about sales and operating costs

and other parts of the balance sheet. Our model was a percentage of sale model where variables

are found by keeping a constant percentage to the sales volume. We found a sales growth rate of

1.26% and used that to project the next 6 years. Using these values, we were able to calculate an

estimated enterprise value of $341 billion and an equity value of $308 billion. A price per share

of $122.81 slightly above the market value at the time of $109.65. Considering our calculations,

we believe that PG was undervalued at the time and investors should purchase the stock.

2. Introduction:
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Proctor and Gamble was founded in 1837 when William Proctor and James Gamble

formed a joint venture combining their Candle and Soap business. The two men met by chance

when they married into the same family. Their father in law Alexander Norris told the two men

they should join together since their two businesses were competing for the same raw materials.

The two formed Proctor and Gamble Company on October 31, 1837 with total assets of just

$7,192. 172 years later PG is one the largest companies in the world with over $115 Billion in

assets and 135 thousand employees.

Today Procter and Gamble is a multinational corporation based out of Cincinnati,

operating in over 70 countries and selling its products in more than 180 countries. PG is the

world's largest maker of consumer goods focusing on home and health products. PG has a large

portfolio of hair, skin and personal, oral, family, feminine, and baby care product lines. Its main

brands are Ace, Bounce, Crest, Gillette, Pampers, Pepto Bismol, Puffs, Old Spice, Swiffer, and

Tide. P&G operates its business globally through five segments: Fabric & Home Care, Baby,

Feminine & Family Care, Beauty, Health Care, and Grooming. Fabric and Home Care is its

largest sector and accounts for around one third of their total sales. Procter and Gamble has been

a consistent financial performer boasting positive net income for the last 10 years. In 2019

revenue eclipsed 68 Billion and net income was over 3.8 Billion. Sales increased by 1% from the

previous year while net income decreased by 59%. This was mostly due to a $8.3 billion non-

cash charge related to Shave Care goodwill and Gillette indefinite-lived intangible assets. This

decrease in net income should not be a concern moving forward.

The goal of our research was to determine the share value of Procter and Gamble by

forecasting its future cash flows and finding a terminal value. Using a sales growth rate of 1.26%

and a long-term growth of 2.5% we were able to find the equity value of the company which was
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just under 308 billion. We then divided our equity value by the 2,505,000 shares outstanding to

find a share value of $122.81. This was 12% higher than the $109.65 market value at the time of

the evaluation. Considering our findings, we believe Proctor and Gamble to be undervalued and

would recommend that investors buy the stock as there is large potential for growth.

3. Data:

During our research we used 4 different databases - SEC Edgar, FINRA, Compustat, and

CRSP. We used Compustat to download PG’s financial statements which were the base for our

projections. We also used their 10-K which we found on SEC Edgar to further break down their

financial statements. It was necessary to further break down the financial statements in order to

compute Net PPE/ Sales and Operating Costs/Sales. We used CRSP data to find the daily price

change and compare that to the S&P 500. By running a market model, regressing PG daily

returns on S&P 500 daily returns and plotting the two on graphs, we estimated the beta of PG

and then computed the cost of equity for PG. We used FINRA to find the companies current

bond issuance as well as the maturity and yield for these bonds. Since PG only had 22 bonds at

the time of evaluation and we needed 100 to compute our average yield we found 78 other bonds

with the same AA- rating. These stocks were from Amazon, Pfizer, Nike and 3M. This allowed

us to compute the company's cost of debt by finding their average yield. Combining our cost of

debt and equity we were able to compute our WACC.

We used data dating back to the beginning of the 2010 fiscal year all the way to 2019.

This allowed us to compute averages and trends based on the last 10 years of the company's

performance. We then used this data to compute projections for the next 6 years until 2025.

4. Methodology:
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The methodology we used for this project was relatively simple. We forecasted unlevered

future cash flows and a terminal value by looking at past historical data and calculating variables

for our assumptions. Our assumptions were used to create a pro forma balance sheet and income

statement to be used to estimate cash flows. Once we had the cash flows and terminal value we

discounted them back using our WACC as our discount rate. The most important variables were

our sales growth rate and our WACC. The sales growth rate was very important because the

majority of our assumptions were based on a percentage of the sales for the year so this growth

rate was the base for our project’s financial statements. It was calculated by taking the average

year over year growth over the last 10 years (Figure 13). However we did exclude 2 years we

deemed outliers because they were out of the norm for the business.

5. DCF Analysis

a. Introduction

In order to create our DCF model, our team first had to organize Procter & Gamble’s

financial statements, then consolidate them, followed by calculating the firm’s WACC

components, then WACC, following by creating assumptions based on various historical

company metrics. We then used the WACC and assumptions in order to create the annualized

pro-forma statements, and finished by analyzing the NPV of the projected future cash flows in

order to estimate enterprise value. In this section, we will discuss the inputs into our WACC

function, as well as the reasoning and explanation for our various assumptions. Then, we will

transition into a discussion of how we combined these two inputs into the creation of our pro-

forma statements and UFCF, and eventually our terminal value and implied share price.
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b. Sales and Financial Ratios

Figure 13. P&G Sales Assumption Calculation

The sales assumptions were calculated using each fiscal year’s total revenue, which we

used to calculate the year over year growth. Figure 13 shows a simple average of all these

revenue growth percentages results in -1.52% growth for P&G. However for our calculations, we

believe that 2015 and 2016 were outliers with significant negative sales growth. P&G is among a

number of companies that blame this negative growth to a strong dollar. P&G earns 2/3s of its

revenues from outside the U.S.; when the Russian ruble was devalued versus the U.S. dollar,

P&G was significant taking hits financially. We believe 2015-2016 doesn't truly reflect the

growth of P&G, our adjusted year over year growth average leaves out these two years, resulting

in an adjusted year over year growth percentage of 1.26%.

Figure 6. CA/Sales & CL/Sales Assumption Calculation

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In order to calculate our current asset/sales, we took current assets for the year and

subtracted cash. We are using this ratio to find our operating current assets. Since cash does not

go negative, we decided to use it as our plug and therefore took it out of our calculation. Once

we found our ratio for each year we took an average of all the years excluding 2016. We felt that

2016 was an outlier as it was a lot higher than the other years. This came out to a ratio of 21%.

To find our Current Liabilities over sale we did the same thing except we did not have an outlier

year so we averaged all 10 years. Our current liabilities were all of the current liabilities minus

short term debt. Our current liability/ sales came out to be 35%.

Figure 11. P&G Operating Cost Assumption Calculation

To calculate the net operating costs/sales assumption figure, we had to obtain operating

costs, depreciation, and sales data from previous years balance sheets. We then found our net

operating costs/sales values from 2010-2019, and averaged the figures to find our model value of

72%, which will be used to project future operating costs.

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Figure 8: Dividend Assumption Model

The dividend growth model was calculated by taking the total dividends value for each

year and calculating the year on year growth. We calculated the dividend growth rate by taking

the CAGR of the dividends per share from 2010-2019. We then found the average growth for

the entire period, and then again excluding the first year. The whole period CAGR of 3.59% is

appropriate for P&G’s future expectations.

Figure 9. Other Liabilities Assumption Calculation

Other liabilities and pensions were selected from the balance sheet. After calculating the

year on year growth from 2010-2019, we used the Compounded Annual Growth Rate of year-

on-year growth to give us the value of .024%.

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Figure 10. Cash & Debt Assumption Calculation

The assumptions for cash, debt, assets and interest are all calculated by selecting balance

sheet data and revenue from the income statement and calculating percentages of cash/sales,

debt/assets, and interest/debt based on the historical data from 2010-2019. Once we calculated

the different financial ratios, we decided to use an average of the 2015-2019 values in order to

come up with our model values. We decided to use the past five years instead of our ten year

historical data because the cash balances for 2010-2014 didn’t reflect the current financial

standing of P&G. The model values we obtained from using the 2015-2019 averages are a

cash/sales ratio of 18.37%, a debt/assets ratio of 17.91%, and an interest/debt ratio of 2.69%.

Figure 12. P&G Analysis of Fixed Assets & Depreciation

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For our fixed asset and depreciation model, we split the PPE into subcategories, then

added all the subcategories up to find out net PPE, which is gross PPT minus accumulated

depreciation.. We then took the sales values for each year from our Income Statement and

calculated PP&E of sales (net PPE/sales) and gross PP&E of sales ((total property +

equipment)/sales)). We then took the average of the past 10 years of net PP&E of sales in order

to find our model value. We chose net PP&E over gross PP&E because it is more stable over

time than gross PP&E of sales.

In order to find our depreciation rate, we first found the percent depreciation of buildings

and land improvements then machinery, equipment and other. We then calculated the

depreciation rates for building and land improvements and machinery. We then found the

average depreciation rate from 2010-2019 and averaged them and came up with our value of

5.73%.
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c. Pro Forma Model

The rationale behind creating a pro forma model is to have an understanding of the

potential future cash flows and costs of a company based on historical data. Projecting out our

balance sheet and income statement is the foundation for calculating P&G’s unlevered future

cash flows. In order to project out P&G’s balance sheet and income statement, we used our list

of assumptions (figure 15) and extrapolated our 2019 values through the end of 2025. In order to

balance total assets and liabilities + stockholders equity, we used cash as our plug. We chose to

use cash because P&G’s capital structure has historically stayed away from issuing additional

debt, which can be shown by P&G’s 95% equity weight.

This caused all of our income statement values to increase over the five year period. Sales

increased from 67.68B in 2019 to 72.981B in 2020, while COGS increased by slightly less, from

49B in 2019 to 52.9B in 2025. Our depreciation changed from 2.8B to 3B, while our after-tax

profit increased from 15.2B to 16.5B.

On our balance sheet, P&G’s cash and marketable securities increased from 10.3B in

2019 to 13.4B in 2025. Our Net PPE actually decreased from 21.3B to 20.2B, caused by

accumulated depreciation rising more than depreciable assets at cost. Next, we saw total assets

rise from 115.1B to 120.1B, with liabilities remaining relatively constant and shareholders equity

increasing by about the same amount as total assets.

d. WACC and Components

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Figure 2. P&G Cost of Equity

In order to calculate our cost of equity, we first had to find P&G’s beta, the market risk-

free rate, and the expected market return. We found the company beta by graphing the daily

return of the P&G stock against the S&P return, and performed linear regression in order to get a

beta value of .52. Then, we looked up the 5-year T-bill and found it to be 1.35% (1), and an

instructed expected market return of 10%. Then, we used the CAPM formula (Rf+beta(Rm-Rf)

in order to calculate our cost of equity, which came out to 5.86%.

Figure 3. P&G Cost of Debt

In order to compute PG’s cost of Debt we used the FINRA database and found all of their

outstanding bonds. We compiled their outstanding bond yields as well as their time to maturity

and plotted them against each other. PG had 22 bonds all rated AA- but this was not enough data

to compute the research. In order to solve this, we found other bonds from companies that have

the same credit rating. Since the bonds have the same rating, they should have comparable
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yields. The companies we used for the rest of our bond data were Nike, Amazon, Pfizer, and 3M.

We plotted our maturity length over the yield and found a trend line with the equation of Y =

-6E-11x2 + 2E-06x + 0.0177. We then computed the average time to maturity which was 3399

days which we plugged into the trend line equation as X to find our average yield. Our average

yield came out to be 2.52%.

Figure 4. P&G Value of Debt

To get the values for the value of debt calculation, we looked to the balance sheet. After

plotting the values from 2015-2019, we used the value of debt formula: ‘net debt = long-term

debt + current portion of long-term debt - current cash and cash equivalents’. This gave us a net

debt of $13,496 at the end of 2019, which is the value we will use to calculate WACC in the

proceeding section.
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Figure 7. Tax Rate Assumption Calculation

The tax rate we used for our model was calculated using a simple average of the previous

two years. We believe this is a more accurate assumption than a total average because it takes

more input from recent trends. Our estimated 2020 tax rate is 30.33%, and will eventually

flatline around 31.7%.

Figure 5. WACC

In order to find the WACC, we first had to find the weight of debt and equity. This was

done by taking the total value of debt and dividing it by the total capital value, giving us value of

4.68%, then we took the total equity and divided it by the total capital value in order to give us
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the equity weight of 95.32%. Then, we used the WACC formula (cost of equity*weight of

equity + cost of debt*weight of debt) in order to get our WACC value of 5.67%.

e. Unlevered Free Cash Flow

Figure 18. P&G Unlevered Free Cash Flow Buildup

Continuing on to our unlevered free cash flow, we first identified our after-tax profit for

each year from our pro forma income statement, then added back our depreciation expense.

Then, we subtracted net working capital (by subtracting the increase in current assets then adding

back the increase in current liabilities). This was followed by subtracting capital expenditures as

well as adding back net interest after tax. The values that we were left with are our unlevered

free cash flows for each forecasted year.

f. Terminal Value

Terminal value is important to us because it essentially creates a value for all future cash

flows which we are unable to estimate. In order to find P&G’s terminal value, we began by using

the unlevered free cash flows and taking our final period (2025) forecast ($11,778) and

multiplied it by our 2.5% long-term FCF growth rate, which we estimated based on the expected

growth of the overall economy. Then, we divided this value by the difference between our

WACC and long-term FCF growth rate, giving us a terminal value of $380,612.

g. Implied Equity Value per Share

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Moving on from our discussion of terminal value, we will now explain how we

calculated P&G’s Equity value per share. Once we calculated the FCF and terminal value for

2025, we added the values together, giving us 392.4B. Using WACC as our discount rate

(5.67%), we used the NPV excel function to calculate our enterprise value of 341B. Then, we

added back the 2019 initial cash value and subtracted the same year’s debt value. This gave us an

imputed equity value of 307.6B.

Then, in order to find the current share value, we divided our equity value by our number

of shares outstanding (2.505B), giving us an implied equity value of $122.81 per share.

h. Sensitivity Analysis

Figure 20. Sensitivity Analysis

We conducted a Sensitivity Analysis where we looked at how the share value changed

with different WACC and long term growth rates. We used growth rates from 1% to 5% at 1%

increments and used WACC rates of 5% to 10.5% at .5% intervals.

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Our share value was not all that sensitive. As WACC increased our share value when

down but the magnitude was not that extreme. The share value was a bit more sensitive to the

long term growth rate. Overall, the majority of the computed values were between $50 and $150.

6. Conclusion and Recommendation

Based on our previous analysis we have found an implied equity value per share of

$122.81. Upon our valuation date of 06/30/2019, PG had a market price of $109.65. The

difference between these two share values show that the price of PG on the valuation date was

undervalued by 12%. In 2015-2016, P&G suffered negative sales growth, but these abnormalities

were attributed to a strong dollar (2). We kept these outliers in mind when valuing P&G’s share

price, maintaining the belief that those were abnormal returns for the normally consistently

upward trending company. As for the future of the company, and the consumer goods industry,

we expect steady growth in sales, and stock price.

Our recommendation to investors is to buy/hold P&G. Based on previous volatility and

steady industry growth, we do not expect any major negative changes in stock price within the

next five years. Based on our sensitivity analysis, a lower LT growth rate as well as a higher cost

of capital could negatively affect P&G’s stock price. P&G should not deviate from their current

capital structure, as they are maintaining a low cost of debt and equity, which keeps their cost of

capital to a minimum and their share price rising.

7. Exhibits
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Figure 1. P&G Consolidated Balance Sheet

Figure 2. P&G Cost of Equity

Figure 3. P&G Cost of Debt/Yield curve

Figure 4. P&G Value of Debt

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Figure 5. WACC Calculation

Figure 6. CA/Sales & CL/Sales Assumption Calculation

Figure 7. Tax Rate Assumption Calculation

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Figure 8. P&G Dividend Assumption Calculation

Figure 9. Other Liabilities Assumption Calculation

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Figure 10. Cash & Debt Assumption Calculation

Figure 11. P&G Operating Cost Assumption Calculation

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Figure 12. P&G Analysis of Fixed Assets & Depreciation

Figure 13. P&G Sales Assumption Calculation

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Figure 14. P&G 10-K Sales (By Sector)

Figure 15. P&G Assumption Overview Table

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Figure 16. P&G Income Statement Projection

Figure 17. P&G Balance Sheet Projection

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Figure 18. P&G Unlevered Free Cash Flow Buildup

Figure 19. P&G Implied Enterprise Value & Equity Value Calculation
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Figure 20. Sensitivity Analysis

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Bibliography:

1. https://ycharts.com/indicators/5_year_treasury_rate

2. https://www.reuters.com/article/us-procter-gamble-results/no-sales-and-profit-

growth-for-pg-in-2015-due-to-strong-dollar-idUSKBN0L01BW20150127