PZ Cussons PLC: Why I would be happy to invest at the right price

PZ Cussons is a favourite among defensive and income-focused investors and for good reason. It has, for example, raised its dividend for 42 consecutive years, which puts it firmly into “dividend aristocrat” territory.

The company has achieved this primarily by selling small-ticket repeat purchase items with strong brands and market-leading positions, such as soap (Imperial Leather), olive oil (Minerva) and washing-up liquid (Morning Fresh).

These high-margin and frequently purchased items give the company a steady and defensive cash income. At the same time, its exposure to emerging markets and willingness to make carefully chosen bolt-on acquisitions have allowed it to grow faster than most other companies.

A solid track record of revenue, earnings and dividend growth

The chart below shows PZ Cussons‘ steady progress over the last few years, as well as its resilience through the financial crisis of 2008/9.

In recent years reported revenues have been a little flat and normalised earnings per share have wiggled, but that should not come as a total surprise given the relatively tough economic environment, especially in emerging markets.

In numerical terms, the company’s track record, compared to the FTSE 100, looks like this (using the metrics from my stock screen):

• Growth rate = 6.6% (FTSE 100 = 2.1%)
• Growth quality = 75% (FTSE 100 = 42%)
• Profitability = 10% (FTSE 100 est. 10%)

Measured against the large-cap market average (PZ Cussons is in the FTSE 250, but for the sake of simplicity I compare all stocks against the FTSE All-Share or FTSE 100) this company clearly has an above-average track record.

Debt levels are growing but not yet excessive

Something else I like to keep a close eye on is a company’s financial obligations. For PZ Cussons those are:

• Debt ratio (ratio of total borrowings to average post-tax profits) = 3
• Pension ratio (ratio of defined benefit pension liabilities to average post-tax profits) = 4.5
• Debt and pension ratio = 7.5

As long as the debt ratio is below 5, the pension ratio below 10 and the debt and pension ratio also below 10, then I’m normally happy. PZ Cussons currently has middling levels of financial obligations and so that’s good enough for me.

I’ve written about those various debt rules before and – if you want – you can calculate all of the metrics mentioned so far with these spreadsheets.

One point to note here is that debt levels have been increasing quite quickly in recent years as the company has been acquiring other companies with borrowed money. While this is okay, I wouldn’t want to see its debt levels go much higher as the risks of borrowed money increase exponentially.

Some large acquisitions, but not too many

Speaking of acquisitions, they are another potential risk (whether funded by debt or not) if they are too large, too frequent or too unrelated to the acquirer’s core business.

In PZ Cussons’ case, there have been several sizeable acquisitions recently, although only one crossed into my definition of “large”, i.e. cost more than an entire year’s profit.

That large acquisition came in 2008 with the acquisition of The Sanctuary – a spa and related beauty products – for £75m at a time when PZ Cussons’ post-tax profits were just £39m.

The Sanctuary’s beauty product business is closely related to PZ Cussons’ personal care products, so the fit appears to have been good. This large acquisition does not appear to have caused any disruption to the core business.

There were other major acquisitions in 2011, 2014 and 2015, but these were also closely related to the core business and also appear to have gone relatively smoothly, at least so far.

No obvious major problems on the horizon

If a company has a strong track record then my final step is to look for what problems it is either facing today or could face in the future.

After reading through the company’s most recent annual report and other recent announcements and news, it seems to be business as usual.

There are no obvious major problems at the moment, although it would be fair to say that the current economic environment is “challenging”. I also couldn’t think of any obvious reason why there would be major problems in the future unless someone works out how to disrupt the soap industry.

And so on that basis, with PZ Cussons appearing to be a solid company with an enviable track record and no obvious impending disasters headed its way, I would be happy to invest in this highly successful business at the right price.

This leads to the question:

What is the right share price for PZ Cussons?

Currently, PZ Cussons’ share price is 270p. At that price, it has the following valuation metrics, as compared to the FTSE 100 at 5,800:

• PE10 ratio (share price to ten-year average earnings) = 18.8 (FTSE 100 = 12.5)
• PD10 ratio (share price to ten-year average dividends) = 42.9 (FTSE 100 = 27.6)
• Dividend yield = 3.0% (FTSE 100 = 4.3%)

At 270p PZ Cussons is not an obvious value investment. Its PE10 and PD10 ratios are higher than the market average, while its dividend yield is lower.

However, it does have a track record of above-average growth and consistency, so it is quite reasonable for it to command a premium price.

After all, you would expect a Rolls-Royce to be more expensive than a Ford Mondeo, but that does not mean the Rolls is worse value for money. The quality of the car could more than justify the higher price (although that is subjective).

However, my stock screen allows me to be somewhat more objective than subjective in my assessment of value as it ranks companies based on a combination of their growth rate, growth quality and profitability, as well as their PE10 and PD10 ratios.

PZ Cussons currently ranks at number 117 on the stock screen out of a total of 235 companies, which is almost exactly midway between 1 (the highest rank) and 235 (the lowest rank). As a result, at 270p PZ Cussons’ share price is, by this measure, almost exactly equal to fair value.

That’s great, but I only want to invest in stocks that are trading some way below their fair value. If I do that then my expected returns are higher and I have a margin of safety in case I’m wrong.

“Some way” below fair value means I’m only interested in the top 50 stocks on my stock screen.

To reach that attractive level PZ Cussons’ share price would have to drop from today’s 270p down to something like 170p.

At 170p per share, PZ Cussons would have a dividend yield of 4.6%, which is slightly better than the market average and would, if the dividend continued to grow at around 7%, give an expected return of around 11% to 12%.

A yield north of 4% would also make the stock much more attractive to other investors which would, in turn, provide a stronger floor under the share price and an incentive for Mr Market to drive the share price back upwards.

Waiting for a bad news day

Of course, getting PZ Cussons’ share price to 170p, which is a 37% decline from where it stands today, would probably require some sort of bad news.

Fears about the global economy, weakening emerging markets or even a profits warning; they’re all the same to me. As long as they’re not life-threatening, can be reversed fairly quickly (and at little cost to the company) and don’t significantly dent its long-term value, then I’m happy to invest in the face of short-term problems.

What I’m not willing to do though is invest at what appears, to me, to be an unexciting share price.

So as is often the case, I will be waiting for PZ Cussons’ price to decline further before investing.