- By Ben Reynolds
(Published by Bob Ciura on July 27)
When it comes to dividends, few companies can match Procter & Gamble (PG). P&G's list of dividend accolades is long and impressive.
It is a Dividend Aristocrat, a group of 51 stocks in the Standard & Poor's 500 Index with 25-plus years of consecutive dividend increases. You can see all 51 Dividend Aristocrats here.
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The intrinsic value of PG
In addition, it is a Dividend King, a group of just 19 stocks with 50-plus consecutive years of dividend increases.
P&G has increased its dividend for 61 consecutive years. Going back even further, it has paid a dividend for 127 consecutive years. At its current share price, P&G has a 3.1% dividend yield.
The combination of 100-plus years of dividends and a 3%-plus dividend yield makes P&G a blue-chip stock in our view. We have compiled a list of stocks with these two qualities.
Business overview
P&G is a diversified, global consumer staples company. It operates around the world, with more than half of annual revenue derived from outside North America. It also has significant exposure to high-growth emerging markets, which make up more than one-third of P&G's annual sales.
Source: 2016 Annual Report, page 2
This is an unusual climate for P&G. It has drastically restructured its business over the past few years. P&G has divested a number of product lines that were either slowing down or were in decline.
The major asset sales include:
Sold Duracell to Berkshire Hathaway (BRK-A) for $4.7 billion.
Sold 43 beauty brands to Coty (COTY) for $12.5 billion.
Over the course of its transformation, P&G went from a massive portfolio of 170 brands down to 65 brands.
The remaining 65 brands encompass 10 core categories, which P&G believes to be the foundation of its future growth. P&G held on to its strongest brands, such as Tide, Pampers and Crest.
These are the brands that carry high margins with potential for growth up ahead.
Source: 2017 Deutsche Bank Global Consumer Conference, page 5
The turnaround made progress in fiscal 2016. While P&G's net sales declined by 8% in 2016, divestments and the strong U.S. dollar played major roles.
As its portfolio becomes more efficient, P&G's cash flow and earnings continue to rise. Operating earnings per share increased 23% for 2016.
P&G's portfolio actions will allow it to retain its competitive advantages and pricing power while freeing itself up to invest more heavily in future growth.
Growth prospects
P&G's earnings growth will be the result of three key factors:
Revenue growth.
Cost cuts.
Share repurchases.
Last quarter, organic revenue increased 1%. P&G expects full-year organic revenue growth of 2% to 3%. A return to organic revenue growth is a good sign that the turnaround is working.
Another key catalyst for earnings growth is cost cutting. The company has taken more than $10 billion out of its cost structure since fiscal 2012.
This has drastically improved margins over the past few fiscal years.
Source: 2017 Deutsche Bank Global Consumer Conference, page 11
From 2013 to 2016, P&G expanded core operating margin by more than five full percentage points.
As a result, P&G's core operating profit margin currently exceeds 20%. According to the company, it now has the third-highest margin in its peer group.
Further cost cuts are in store. P&G believes it can reduce expenses by another $10 billion over the next five years.
P&G will increase earnings from share repurchases. It expects to utilize more than $14 billion this year for share reductions.
These initiatives had had tangible results this year. Core earnings per share increased 12% last quarter or 15% excluding currency.
For the full fiscal year, P&G expects adjusted earnings to increase at a midsingle-digit rate from last year.
Competitive advantages and 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 brands that will represent the future of the company hold leadership positions in their respective categories. These products are associated with high quality, and consumers will pay a premium for them.
This is true even during recessions. P&G's financial performance during the Great Recession is as follows:
2007 earnings per share of $3.04.
2008 earnings per share of $3.64 (20% increase).
2009 earnings per share of $3.58 (2% decrease).
2010 earnings per share of $3.53 (1% decrease).
P&G enjoyed strong earnings-per-share growth in 2008 and experienced only a mild dip over the next two years.
It remained highly profitable in one of the worst recessions since the Great Depression.
The other major catalyst for P&G is scale. As one of the largest consumer products companies in the world, P&G benefits from the ability to squeeze as many costs out of its operating structure as possible.
For example, by the end of the current fiscal year, P&G expects its restructuring to have reduced nonmanufacturing roles by 35%.
A lean business model helps P&G increase margins, which then results in earnings-per-share growth.
Valuation and expected total returns
P&G had core earnings per share of $3.76 per share in fiscal 2016. Based on its current share price, the stock has a price-earnings (P/E) ratio of 23.8.
This is a slight discount to the S&P 500 Index, which has an average P/E ratio of 24.7.
P&G is not overvalued since it is a high-quality company with a strong dividend. That said, there is likely only limited room for further expansion of the valuation multiple.
As a result, future returns will not likely be generated by an expanding P/E ratio. Fortunately, P&G will still generate returns from earnings growth and dividends.
A potential breakdown of P&G's future earnings growth is as follows:
2% to 4% organic revenue growth.
1% margin expansion.
2% to 3% share repurchases.
3.1% dividend yield.
Using this scenario, total returns would reach 8% to 11% per year moving forward.
P&G's dividend is a significant contributor to its total returns. This should come as no surprise as the company has paid a dividend for more than 120 years.
The current dividend payout is sufficiently covered by earnings. Based on fiscal 2016 results, P&G has a payout ratio of approximately 73%. This leaves enough room for future dividend increases, likely in the low to mid-single digits.
Final thoughts
P&G has experienced more change in the past year than many investors would normally associate with a blue chip. After all, blue chips typically have a reputation for steady, consistent growth.
Investors should feel good about where P&G is and where it is going from here. The company became a bit of a lumbering giant in recent years but has shed several brands that were weighing it down.
For investors interested in owning a high-quality business with a reliable dividend, P&G is a strong choice.
Disclosure: I am not long any of the stocks mentioned in this article.
This article first appeared on GuruFocus.
