Key Points
Proctor & Gamble had a solid quarter with impressive margins.
Cash flow and FCF are sufficient to sustain the outlook for capital returns and capital return growth. 
Analysts view this stock as undervalued and forecast a double-digit upside for the market. 
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Proctor & Gamble’s NYSE: PG stock price entered consolidation following the  COVID-19 bubble, but its uptrend is intact, and a trend-following signal is in play. Because the stock has sustained such a profound trend and is deeply undervalued, the potential for gains ranges from 25% to 50% over the next two to three years.
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Regarding the value, this stock is trading near 23X its earnings, 21X the next year’s consensus, which isn’t exactly cheap for the S&P 500 NYSEARCA: SPY or consumer staples—however, the entire consumer staples complex trades at or near deep-value territory, including Proctor & Gamble. The stock’s average P/E for the last ten years is above 28X, suggesting a significant price-multiple expansion can happen as economic conditions normalize and appetite for staples recovers. 
Analysts generally agree that this Dividend King is undervalued. They rate the stock at Moderate Buy and have been raising their targets for the last twelve months, pushing the consensus up 8.5% to a level more than 12% above the current action. More importantly, the stock trades about 2% below the analysts’ lowest target, enhancing the value opportunity. The Q2 release and guidance may not spur the analyst community to raise their targets again, but no negative revisions are expected. 
Proctor & Gamble’s mixed results strong where it counts
Proctor & Gamble had a mixed result for Q2, but this is relative to consensus estimates, and the news is nothing but good in the places where it counts. Revenue came in at $21.44 billion and missed the consensus target, but the miss is slim and easy to overlook. Revenue grew by 3.2% YOY and helped drive wider margins, which was impressive. All segments produced growth led by a 9% organic gain in grooming and a 6% increase in Fabric and Home. Strength is supported by pricing increases of 4%, offset by a 1% decline in volume. The 1% decline in volume is noteworthy because elasticity remains low, and pricing power is evident. 
The margin news is fantastic. The GAAP results declined YOY due to a non-cash brand impairment; the adjusted earnings grew and showed the leverage of pricing actions. The company’s gross margin improved by 520 basis points, operating by 400. SG&A expenses increased YOY but were less than the revenue gain and were offset by favorable commodity costs expected to aid the margin as the year progresses. The $1.84 adjusted earnings is up 16% compared to the 3.2% top-line gain and beat by 820 bps. 
Guidance is also favorable to shareholders. The company maintained its revenue guidance but raised the range for earnings to a level bracketing consensus. The new guidance expects adjusted EPS growth from 8% to 9% and may be cautious given the company’s momentum. 
Proctor & Gamble capital returns are safe 
Among the takeaways from this report are the company’s considerable cash flow, FCF productivity and capital returns. The company generated $3.5 billion in cash flow with a 95% productivity rate. The $3.325 billion in FCF being sufficient to cover the $3.3 billion in dividend payments and share repurchases. 
The dividend is worth about 2.5% at 60% of earnings, leaving plenty of room for dividend increases. Because the company is forecasting earnings growth at the high end of the range, it should sustain its mid-single-digit distribution CAGR for a 68th consecutive increase and the pace of repurchases. Repurchases in F2024 increase the effective yield by 55% to 65%. 
The technical outlook: PG fires a trend-following signal

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