P&G: Growth Potential in China, Portfolio Transformation to Provide Upside

Growth in China and a refocused portfolio will provide long-term growth

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Jan 25, 2017
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The consumer goods industry will have its share of growth in a slightly tight market condition. With a market cap of $235 billion and vast geographical presence, Procter & Gamble Co. (PG, Financial) is one of these companies. Although some investors are skeptical about the company’s performance based on its relatively high valuation, I believe the company is poised for growth and any dip in price will be a good buying opportunity for income investors.

Company and business overview

Procter & Gamble provides consumer packaged goods to consumers in North America, Europe, the Asia Pacific, India, the Middle East, Africa and Latin America. The company operates in four segments:

  • Beauty
  • Baby, feminine and family care
  • Fabric and home care
  • Health and grooming

Fabric and home care contributed to about 32% of the company’s sales, followed by baby, feminine and family care with 28%. Developed nations contributed to 65% of the company’s revenue and developing nations contributed the remaining 35%. Proper implementation of a growth strategy in China will result in greater sales contributions by developing nations in the coming years.

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A well-established company that is a market leader can always be considered a safe investment for low-risk investors.Ă‚ With a presence in more than 180 countries and products catering to almost all of an individual's needs, P&G is an attractive business for investors to consider for the long term.Ă‚

Dividend Aristocrat

P&G currently pays an annualized dividend of $2.68 per share, which brings its dividend yield to 3.1%. This is higher than Colgate-Palmolive’s (CL, Financial) yield of 2.3% and Estee Lauder’s (EL, Financial) 1.7% yield. The company’s dividend yield is also higher than the Dow Jones Industrial Average's yield of 2.4% and the S&P 500’s yield of 2.15%.

In addition, the company's payout ratio of 0.75 is above the industry average of 0.69. An attractive dividend payout ratio along with its 60-year history of paying dividends makes the company a good dividend stock. Moreover, investors looking for a secure cash inflow should consider the stock on any correction.

Second-quarter 2017 results

The company’s long-term goal is to increase organic sales, EPS growth and free cash flow. Taking this as the base of our comparison, the company has fared well in terms of organic growth. It recorded organic sales growth of 2% for the second quarter. The company also reported EPS growth of 4%, while the operating margin was flat compared to last year. The improvement in its gross margin was driven by cost savings, but was offset by marketing investments and currency headwinds. The company had adjusted free cash flow productivity of 115% for fiscal 2016 and 85% for first-quarter 2017. Although the company lagged by few percentage points in the first quarter, I believe the company’s goal of transforming its portfolio will help it to achieve its target.

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Portfolio transformation

In regard to the its portfolio transformation strategy, P&G has been successful in simplifying its business, which has resulted in a more streamlined operation. The company reduced its portfolio from approximately 170 brands to 65. Its primary focus on a stronger portfolio is to maximize shareholder value. P&G expects to pay at least $7 billion in dividends and at least $5 billion in share repurchases for 2017. This has resulted in further positive organic growth for both the first and second quarters and stronger EPS and free cash flow growth. Therefore, I Â believe a simpler business structure with fewer brands to focus on will help P&G meet its customers’ needs while simultaneously achieving balanced sales growth and margin expansion.

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China: Biggest growth potential

China is the company’s second-largest market and biggest opportunity. P&G has seen more than 25% growth in its SK-II products for fiscal 2016. Its market share growth was led by body wash and liquid hand soap sales. Considering China’s per capita income is increasing and consumers are willing to purchase premium products, there is potential for the company to gain deeper market penetration. For this reason, I believe China will be a key factor in P&G’s growth.

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Conclusion

Procter & Gamble has ample free cash flow and a wide portfolio of products. Considering the company’s secure dividend yield of 3.1%, I believe it is well positioned for long-term growth and any weakness in the market can be considered a good buying opportunity.

Disclosure: No position in the stocks discussed.

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