Published November 30th, 2016 by Bob Ciura
Until recently, Procter & Gamble (PG) stock was performing well throughout 2016. After closing out 2015 trading around $80, P&G stock climbed as high as S90 by October. And then, things went south…
Global economic uncertainty has caused a sell-off in the consumer staples sector. P&G stock shares have lost 6% over the past three months. The contributors to heightened uncertainty are the Brexit vote, the U.S. elections, and rising interest rates.
But looking past the scary headlines, P&G’s turnaround remains on track. Its major restructuring has included the sale of Duracell and dozens of other low-growth brands.
These asset sales have allowed the company to turn itself in a new direction. P&G is now more streamlined and can focus on its top brands. For the first time in years, P&G is on a path of growth.
This is great news for shareholders, especially those who own P&G for its dividend. That’s because returning to earnings growth could allow P&G to provide more generous dividend hikes next year and beyond.
P&G has seen a prolonged slowdown. For example, net sales fell by 8% in fiscal 2016. But now that its portfolio restructuring is complete, it is beginning to see the benefits of slimming down.
In the fiscal 2017 first quarter, sales rose 3% excluding the impact of currency fluctuations. Earnings-per-share, adjusted for currency and non-recurring expenses, increased 5%.
This may seem like modest growth, but it is a significantly better result than P&G has seen for an extended period.
Source: 2016 Analyst Meeting presentation, page 5
A big reason for this growth is P&G’s huge asset sales. In 2014, it sold the Duracell brand to Warren Buffett’s Berkshire Hathaway (BRK.B) for $4.7 billion. Then, it sold a portfolio of 43 beauty brands to Coty (COTY) for $12.5 billion.
Overall, P&G is making massive cuts to its brand portfolio. Moving forward, it intends to focus on 10 core categories and the following brands:
- Fabric Care (Tide, Gain, Downy)
- Home Care (Febreze, Swiffer, Mr. Clean, Dawn)
- Grooming (Gillette, Venus)
- Oral Care (Crest, Oral-B, Fixodent)
- Baby Care (Pampers, Luvs)
- Feminine Care (Tampax, Always)
- Family Care (Bounty, Charmin)
- Personal Health Care (Pepto Bismol, Prilosec, Vicks)
- Hair Care (Head & Shoulders, Pantene)
- Skin and Personal Care (Old Spice, Olay, Ivory)
These are the highest-growth brands with the best opportunities for additional growth. P&G saw broad-based growth across these core categories last quarter.
Source: 2016 Analyst Meeting presentation, page 7
In addition to sales growth, P&G will use some of the proceeds of its asset sales to buy back its stock.
On top of that, P&G plans to repurchase more than $14.5 billion of its own stock this year, thanks in part to the Coty transaction windfall.
Source: 2016 Analyst Meeting presentation, page 15
Plus, the company has already set aside more than $7 billion for shareholder dividends this year. In all, P&G expects to return a whopping $22 billion to shareholders this fiscal year.
The company’s asset sales provide it with significant capital that it can use to reinvest back into future growth initiatives, and reward shareholders at the same time.
P&G has several competitive advantages that will contribute to the success of its turnaround. First, it still has 20 brands that bring in $1 billion or more in annual sales.
Its strong brands provide the company with pricing power. A significant portion of P&G’s future revenue growth comes from price increases.
The company retains its brand reputation because of its R&D and advertising. P&G spends billions on R&D:
- 2016 R&D expense of $1.9 billion
- 2015 R&D expense of $2 billion
- 2014 R&D expense of $1.9 billion
It also spends aggressively on advertising:
- 2016 advertising expense of $7.2 billion
- 2015 advertising expense of $7.1 billion
- 2014 advertising expense of $7.8 billion
Another competitive advantage for P&G is its scale. P&G is a huge company with the financial flexibility to cut costs across its business when it deems necessary. For example, P&G’s headcount has declined every year since 2011.
P&G has cut costs significantly. In the past five fiscal years, cost savings have exceeded $10 billion. Most of the cuts have come across cost of goods sold, marketing, and overhead.
P&G expects to generate an additional $10 billion in cost savings over the next five years. These savings will come mostly from cost of goods sold.
Source: 2016 Analyst Meeting presentation, page 29
These competitive advantages provide a solid floor underneath P&G’s earnings-per-share, which is crucial for the dividend. The sooner P&G returns to earnings growth, the sooner it can accelerate its dividend growth rate.
P&G is known as a premier dividend growth stock. Indeed, P&G has raised its dividend for 60 years in a row. This qualifies P&G as a Dividend Aristocrat (more than twice over). Dividend Aristocrats are stocks with 25+ years of consecutive dividend payments; the ‘best of the best’.
But its dividend hikes in recent years have been tiny. The company has opted to allocate greater amounts of capital to support its turnaround efforts. P&G’s 2016 dividend increase was just 1%.
Fortunately, accelerating earnings-per-share growth could allow the company to increase its dividend at higher rates moving forward.
Source: 2016 Analyst Meeting presentation, page 13
P&G management projects 2% organic sales growth in the upcoming fiscal year. This should be more than enough to generate mid-single digit earnings-per-share growth, along with cost cuts and share repurchases
A breakdown of potential earnings growth could be as follows:
- 2% revenue growth
- 1% margin expansion
- 2% share repurchases
Going forward, P&G could easily generate 5% earnings-per-share growth each year. This would allow the company to increase its dividend by 5% per year, and not elevate its dividend payout ratio.
P&G has taken investors on a bumpy ride over the past few years. But the journey is almost complete. The company is making the right choice by focusing its future investment on the brands that will generate the highest growth.
Investors that have stuck with P&G will likely be rewarded next year and beyond with a return to higher dividend growth rates. This means P&G continues to be a very valuable stock holding for dividend growth investors.