(Published by Bob Ciura on April 28)
Procter & Gamble Co. (PG, Financial) is a rare stock because of its tremendous dividend history.
It is one of just 51 stocks on the list of Dividend Aristocrats, companies with at least 25 consecutive years of dividend increases.
See the entire list of Dividend Aristocrats here.
Not only is it a Dividend Aristocrat, it is also one of only 19 Dividend Kings—these are stocks with over 50 years of dividend increases.
See the complete list of Dividend Kings here.
P&G has paid a dividend for more than 120 years and has raised it each year for six decades running.
Over that period, every so often P&G has had to reinvent itself. This is one of those times—the company is in the process of a major portfolio restructuring.
The company is slimming down to become more efficient and position itself to return to growth.
The turnaround is gaining momentum. On April 26, P&G released fiscal third-quarter 2017 earnings that showed its turnaround remains on track.
Quarterly performance overview
A quick rundown of P&G’s results from its fiscal third quarter:
- Revenue: $15.61 billion (down 1% year over year)
- EPS: 96 cents per share as adjusted (up 12% year over year)
The results were mixed in terms of analyst expectations. Earnings per share beat estimates by two cents per share, while quarterly revenue fell short by approximately $120 million.
Last quarter represented the strongest earnings growth rate for P&G over the past five quarters.
Source: Q3 Earnings Presentation, page 4
P&G generated strong earnings growth for the quarter due to improved efficiency.
One factor that held the company back last quarter was unfavorable foreign exchange rates. The strong U.S. dollar has negatively impacted revenue growth for companies that have high levels of international exposure, such as P&G.
P&G sells its products in more than 180 countries around the world. More than half of its sales in fiscal 2016 were conducted outside North America.
A stronger U.S. dollar, relative to international currencies, makes exports less competitive with locally produced goods.
Source: 2016 Fact Sheet, page 1
Foreign exchange caused P&G’s net sales to decline 1% for the quarter. Organic sales, excluding the impact of currency and divestitures, increased 1% last quarter.
P&G realized organic sales growth in four out of its five segments, led by health care, up 6% for the quarter.
The health care product segment generated 12% earnings growth last quarter, or 14% growth excluding the impact of currency fluctuations.
Growth was due to a combination of favorable pricing and product mix. In addition, developing markets outperformed developed markets.
Source: Q3 Earnings Presentation, page 11
The worst-performing segment last quarter was grooming, which posted a 6% organic sales decline.
P&G’s grooming segment is anchored by its flagship Gillette brand. Premium-priced shaving products are under pressure from upstart competitors like Dollar Shave Club, which Unilever (UL) acquired last year for $1 billion.
Outside grooming, P&G’s growth shows its turnaround is working.
Even though P&G’s international exposure is hurting the company now, it should be a benefit over the long term. The company generates roughly two-thirds of its sales from underdeveloped markets.
Emerging economies are growing at a faster rate than mature markets and have led P&G’s growth throughout fiscal 2017.
Sales in developing markets rose 5% in the first half and increased 4% last quarter. By contrast, the U.S.—P&G’s largest market—had sales growth of 2% in the first half, but was up less than 1% last quarter.
Growth prospects
P&G’s double-digit earnings growth is the byproduct of the company’s major portfolio restructuring.
Now that its divestment period is over, P&G will focus on approximately 65 brands in 10 product categories.
Source: 2016 Fact Sheet, page 2
As a result, the "new" P&G will be led by its core brands going forward.
A sample of its biggest brands include:
- Bounty
- Charmin
- Crest
- Downy
- Febreze
- Gain
- Gillette
- Head & Shoulders
- Olay
- Pampers
- Tide
In 2016, P&G completed major asset sales. It sold off dozens of brands that were deemed non-critical to its future strategy.
A few of its major asset sales include:
- Duracell battery business sold to Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) for $4.7 billion.
- 43 beauty brands sold to Coty Inc. (COTY, Financial) for $12.5 billion.
When P&G made these transformative deals, its reasoning was they were low-growth brands that weighed the company down.
By selling them off, P&G could raise billions of dollars, which it used for share repurchases and investments in product innovation in its remaining core brands.
These efforts are working well, judging by its third-quarter earnings growth. For the full fiscal year, P&G expects mid-single-digit growth in adjusted EPS.
In addition, P&G removed $10 billion from its cost structure. Selling, general and administrative expenses, as a percentage of overall revenue, fell by 40 basis points from the same quarter last year.
P&G’s improved efficiency should strengthen its cash flow generation, which supports its annual dividend increases.
Dividend analysis
Last quarter, P&G had adjusted free cash flow of $2.3 billion. It utilized $1.8 billion for dividends.
In 2017, P&G expects to pay shareholder dividends of over $7 billion.
P&G’s dividend is one of the most compelling reasons to own the stock. P&G has a 3.1% dividend yield, which his significantly above the average stock in the S&P 500 Index.
Even better, P&G has paid a dividend for 127 years, since its incorporation in 1890. It has also raised its dividend for 61 years in a row.
The remarkable consistency demonstrates the power of P&G’s brands and its durable competitive advantages.
It has continued to raise its dividend payout each year, in good times and bad. Its most recent increase was a 3% hike.
After the dividend increase, P&G’s annualized payout is approximately $2.76 per share. The company generated core EPS of $3.76 per share in fiscal 2016.
As a result, P&G’s payout ratio based on 2016 EPS is 73%. This is a fairly tight payout ratio, which explains the company’s low dividend growth rate over the past few years.
That said, the company’s turnaround has provided it with accelerating earnings growth. If this continues, P&G could improve upon its dividend growth in 2018 and beyond.
Final thoughts
P&G’s sales growth disappointed last quarter due to foreign exchange. More importantly, the company's turnaround remains on track.
Sales are growing in organic terms and its portfolio restructuring has led to double-digit earnings growth.
This is clear evidence the company’s turnaround plan is working. Assuming its recovery continues, investors may see higher dividend growth from P&G next year.
Disclosure: I am not long any of the stocks mentioned in this article.
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