Updated on February 11th, 2019 by Bob Ciura
The Dividend Aristocrats are a group of 57 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Once per year, we review each of the Dividend Aristocrats. Up next in the 2019 series is consumer products behemoth Procter & Gamble (PG).
P&G has increased its dividend for an amazing 62 consecutive years.
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 fewer than 25 Dividend Kings, including P&G. You can see all the Dividend Kings here.
Procter & Gamble is one of the most well-known dividend stocks, largely due to this dividend history. The company’s poor recent revenue performance has led some investors to question the safety of its future dividend payments. You can watch a video analysis on Procter & Gamble’s dividend safety here:
Things are looking up for the company. 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.
During 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: Investor Day Presentation
The company now operates five reporting segments, based on the following product categories:
- Fabric & Home Care (32% of sales)
- Baby, Feminine, & Family Care (27% of sales)
- Beauty (19% 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.
The effect of the transformation is that P&G is now a nimbler, more flexible organization with renewed 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 was 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. In the most recent fiscal quarter, revenue of $17.4 billion rose 0.2% from the same quarter last year, and beat analyst expectations by $280 million. Adjusted earnings-per-share of $1.25 increased 13% excluding currency, and beat analyst expectations by $0.04 per share.
Organic sales (which excludes currency fluctuations, acquisitions, and divestments) increased 4% for the period. Breaking down Procter & Gamble’s results by product segment, Beauty products led the way with 8% organic sales growth, followed by Fabric & Home Care with 6% growth. Health Care segment organic sales increased 5%, while Baby, Feminine, and Family Care sales increased 3%.
Growth in these segments was partially offset by a 3% sales decline in Grooming products. Procter & Gamble also maintained fiscal 2019 guidance. The company is expecting 3% to 8% adjusted earning-per-share growth, for adjusted earnings-per-share of $4.45 at the midpoint.
Margin expansion is a major component of P&G’s earnings growth strategy. P&G’s cost-cutting efforts have elevated its operating margins and after-tax profit margins toward the top of its peer group.
Source: Investor Day Presentation
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. 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 35% of P&G’s annual sales are derived from developing markets such as China, India, the Middle East, and Africa, which are all attractive new growth markets.
P&G will continue to make acquisitions to accelerate its growth in new markets, such as the $4.2 billion acquisition of Germany-based pharmaceutical giant Merck’s global consumer health business. The acquisition includes 10 core brands in vitamins, nutritional supplements, and other over-the-counter products. According to Merck, the global OTC market is expected to grow 5% annually through 2025, which explains why P&G wants to invest more heavily in this area.
Finally, P&G’s digital platform is a catalyst for future growth. In fiscal 2018, P&G’s global e-commerce sales increased 30% for the year, to nearly $4.5 billion. There is plenty of room for continued growth in e-commerce, as this booming segment still represents just 7% of the total business.
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:
- 2016 advertising expense of $7.2 billion
- 2017 advertising expense of $7.1 billion
- 2018 advertising expense of $7.1 billion
P&G also invests nearly $2 billion each year in research and development. This investment is a competitive advantage for P&G; R&D fuels product innovation, while advertising helps market new products and gain share.
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 $4.45 expected in fiscal 2019, P&G stock has a price-to-earnings ratio of 22.1.
The stock is currently trading at a premium its 10-year average valuation of 18.8; as a result, P&G appears to be fairly valued, to slightly overvalued. Our fair value estimate for P&G is a price-to-earnings ratio of 20.
If P&G’s stock valuation retraces back to the fair value estimate, future returns would be reduced by 2% per year over the next five years.
Earnings growth and dividends will help offset the impact of a contracting price-to-earnings multiple. We expect P&G to generate 5% annual earnings growth through 2024. And, the stock has a current dividend yield of 3.0%.
Adding it all up, total returns would be approximately 6% per year over the next five years.
The current dividend payout is well-covered by earnings, with room to grow. Based on expected fiscal 2019 earnings, P&G has a payout ratio of approximately 66%. 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.
However, right now is not the best time to buy P&G stock because it is overvalued. This limits the total return potential for the stock over the next five years.
Because of this, P&G stock remains a hold for dividend growth investors, and would earn a buy recommendation on a meaningful pullback from present levels.