$PG – Currency Crests

by Dan May 16, 2016 12:17 pm • Commentary• Trade Ideas

When Proctor & Gamble (PG) reports their fiscal Q4 results in early August the company will likely print an eps decline of 10% for fiscal year 2016 with a 15% sales decline. The expected $65 billion in sales for fiscal 2016 is expected to be $19 billion, or 23% below their peak sales of $84.5 billion in fiscal 2013, with eps 10% below 2013 levels.

Despite a rally in 2014 to nearly $95, and a decline in 2015 to nearly $65, the stock is just a couple bucks above the mid point of that range at $80, exactly where it was at the end of 2013, the year eps and sales peaked:

PG 3yr chart from Bloomberg
PG 3yr chart from Bloomberg

So why on earth would an investor pay 20x expected 2017 eps that maybe rebounds to high single digit growth and low single digit sales growth? Yeah, the 3.27% dividend yield, and the company’s commitment to managing earnings (oops I mean cash return through buybacks), but it seems to me that consumer staple stocks are mis-priced given what is likely to be an increasingly volatile impact of foreign exchange rate on the increasing share of off-shore sales, as growth will have to come from overseas.  It’s interesting to note that the the impact of FX was listed as first a headwind, and then a tailwind in PG’s fQ3 earnings presentation from a couple weeks back:

FY 2016 Guidance
Potential Headwinds Not Included in Guidance
Further foreign currency weakness
• Change in market growth rates
• Further unrest in the Middle East, Russia & the Ukraine
• Further deterioration in markets like Argentina and Brazil – with softened market conditions

FY 2016 Guidance
Potential Tailwinds Not Included in Guidance
Strengthening of foreign currencies
• Expansion of markets
• U.S. economic growth accelerates

A quick look at the U.S. Dollar Index (DXY) vs PG since mid 2013 shows the tight correlation up until the DXY topped out in early 2015 high and then became range-bound, well above the 2013 lows:

DXY vs PG from Bloomberg
DXY vs PG from Bloomberg

I am not exactly sure what you do with this, the multi-year in the DXY last year was initially good for PG, then quickly very bad. The recent weakness in the DXY on a year over year basis has been vol dampening, as the stock has based between $80 and $84 for the better part of the last three months.  I suspect a sharp rise in the DXY would cause PG to breakdown below $80, but that will only happen if expectations for a Fed rate hike were to increase dramatically, which seems fairly unlikely when you consider the weak jobs data we got last week for April and the continued weak economic data in China.

On the flip-side, if the DXY were to breakdown and retrace some of that ramp from 2014, then I suspect that will be in response to an increasingly dovish U.S. Fed that remains concerned about the pace of the U.S. recovery and continued caution about global growth. In that scenario, I suspect PG’s sales suffer in emerging markets to the point where the benefit of the weak dollar do not offset weak demand.  So damned if they do, damned if they don’t at 20x expected eps. In my opinion.

If I were long shares of PG, I might consider overwriting.  For instance with the stock at $81.50, the July 82.50 calls can be sold at $1.40, with an implied call-away level of $83.90, up 3% from current levels, July expiration will not catch fQ4 earnings.

If I thought PG were to breakdown below $80 in the coming months, I might consider buying the July 80/77.50 put spread for 60 cents as either a hedge vs long stock or an outright play for a move lower.

For those simply looking to take advantage of PG possibly being stuck in a range between the push and pull of currency in the damned if they do, damned if they don’t environment, the June 82.5/80/77.5 put fly is offered at .60 has breakevens of 81.90 and 77.10 with a max gain of up to 1.90 if the stock is 80 on June expiration. 80 is also the center between the 50 day and 200 day moving averages.