Published by Bob Ciura on November 17th, 2017
The Dividend Aristocrats are a group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Once per year, we review each of the 51 Dividend Aristocrats. Up next in the 2017 series is consumer products behemoth Procter & Gamble (PG).
P&G has a very long history of raising dividends. Not only is it a Dividend Aristocrat, it is a Dividend King as well. The Dividend Kings have increased their dividends for 50+ consecutive years. There are just 23 Dividend Kings, including P&G. You can see all 23 Dividend Kings here.
P&G recently completed a major overhaul of its product portfolio. It is now more focused and efficient, with renewed growth potential.
This article will discuss P&G’s recent portfolio transformation, future growth prospects, and stock valuation.
P&G is a global consumer products giant. It sells its products in over 180 countries around the world. It generates over $65 billion in annual sales. Approximately 55% of sales are derived from outside North America.
P&G’s massive portfolio restructuring over the past few years, the company sold off dozens of consumer brands. Its recent sales include battery brand Duracell to Berkshire Hathaway (BRK-A) for $4.7 billion, and a collection of 43 beauty brands to Coty (COTY) for $12.5 billion.
Today, P&G has slimmed down to just 65 brands, down from 170 previously.
Source: Barclays Global Consumer Conference, page 8
The company now operates five reporting segments, based on the following product categories:
- Fabric & Home Care (32% of sales)
- Baby, Feminine, & Family Care (28% of sales)
- Beauty (18% of sales)
- Health Care (12% of sales)
- Grooming (10% of sales)
The benefit of the restructuring is that P&G held onto its core consumer brands such as Tide, Charmin, Pampers, Gillette, and Crest, while shedding low-margin businesses with limited growth potential.
P&G’s slimmed down portfolio has made the company more efficient, with lower costs and higher margins.
In addition, P&G received billions of dollars from its various asset sales, a large portion of which is used to buy back stock. The company utilized $14.6 billion for share reduction in fiscal 2017.
This has improved P&G’s earnings growth. Organic revenue increased 2% in fiscal 2017. Core earnings-per-share increased 7%, thanks to share repurchases and cost cuts.
Margin expansion is a major component of P&G’s earnings growth strategy.
Operating margin reached 22.1% in the most recent fiscal year, up 270 basis points from fiscal 2013.
As part of the restructuring, P&G launched a massive cost-cutting effort. P&G cut costs by $10 billion over the course of its restructuring, through headcount reduction and lower SG&A expenses.
Source: Barclays Global Consumer Conference, page 14
Company management sees the potential for another $10 billion in additional cost savings by fiscal 2021.
Another growth catalyst for P&G is through expansion in under-developed economies. Emerging markets like China and India are fertile territory for large consumer products companies like P&G. These two countries have populations over 1 billion each, with rising middle classes.
Approximately 15% of P&G’s annual sales are derived from China, India, the Middle East, and Africa, which are all attractive new growth markets. Over one-third of total sales come from developing markets.
In the fiscal 2018 first quarter, organic revenue increased 1%, while core earnings-per-share rose 6% from the same quarter last year.
For the upcoming fiscal year, P&G expects organic revenue growth of 2%-3%, along with earnings growth in the 5%-7% range.
Competitive Advantages & Recession Performance
P&G has several competitive advantages. The first is its strong brand portfolio. P&G has several brands that generate $1 billion or more in annual sales.
The 65 remaining core brands hold leadership positions in their respective categories. These products are associated with high quality, and consumers will pay a premium for them.
To retain its competitive position, the company invests heavily in advertising, which it can do thanks to its financial strength.
P&G’s advertising spending in recent years is as follows:
- 2015 advertising expense of $7.2 billion
- 2016 advertising expense of $7.2 billion
- 2017 advertising expense of $7.1 billion
P&G also invests nearly $2 billion each year in research and development. R&D fuels product innovation, while advertising helps market new products and gain share.
The investments in R&D and advertising have helped P&G gain top market share across multiple brands.
Source: Morgan Stanley Global Consumer Conference, page 14
P&G’s competitive advantages allow the company to remain profitable, even during periods of recession. Earnings held up very well during the Great Recession:
- 2007 earnings-per-share of $3.04
- 2008 earnings-per-share of $3.64 (20% increase)
- 2009 earnings-per-share of $3.58 (1.6% decline)
- 2010 earnings-per-share of $3.53 (1.4% decline)
As you can see, P&G had a very strong year in 2008, with 20% earnings growth. Earnings dipped only mildly in the following two years.
This was a very strong performance, in one of the worst economic downturns in the past several decades. P&G has a recession-resistant business model. Everyone needs paper towels, toothpaste, razors, and other P&G products, regardless of the economic climate.
Valuation & Expected Returns
Based on adjusted earnings-per-share of $3.92 in the most recent fiscal year, P&G has a price-to-earnings ratio of 22.8.
The stock is currently trading at a premium of approximately 24% to its 10-year average valuation. As a result, P&G appears to be fairly valued, to slightly overvalued.
Source: Value Line
As a result, investors should not expect P&G’s price-to-earnings multiple to expand much beyond the current level. If anything, there appears to be a greater likelihood that the valuation multiple could contract going forward.
P&G shares currently trade well above its 10-year average, and the company has modest earnings growth expectations, which may not warrant a valuation premium.
Going forward, expected returns will be generated from earnings growth and dividends. A potential breakdown of P&G’s future earnings growth is as follows:
- 2%-3% organic revenue growth
- 0.25%-0.5% margin expansion
- 2% share repurchases
- 3% dividend yield
In this forecast, total returns would be approximately 7%-9% per year, moving forward.
The current dividend payout is covered by earnings, with room to grow. Based on fiscal 2017 earnings, P&G has a payout ratio of approximately 70%. This leaves enough cushion for future dividend increases each year, in the low-to-mid single digit range.
P&G has many strong qualities. It is a highly profitable company, with strong brands, and global growth opportunities.
And, it has a long history of rewarding shareholders with dividends. P&G has been paying a dividend for nearly 130 years.
With an operating history of over 100 years, and a 3% dividend yield, P&G earns a place on our list of “blue chip” stocks. We have compiled a list of several dozen stocks with these two qualities. You can see the full list of blue chip stocks here.
P&G stock is not undervalued, but the company remains a strong dividend growth stock.