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.
Procter & Gamble is one of the most well-known dividend stocks, largely due to this dividend history. However, 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.
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.