By: Ahmed Ishtiaq
Procter & Gamble Co (PG) provides branded consumer packaged goods. It markets its products in about 180 countries through mass merchandisers, grocery stores, membership club stores, drug stores, department stores. Recently, unfavorable foreign currency exchange rates, slowing growth rates in developed and emerging markets and competitive pricing has caused the company to underperform. However, through some cost cutting methods, the company is targeting 8-10% EPS growth rate. Furthermore, Procter & Gamble is also looking to free up some capital to invest in business.
P&G offers impressive dividends and a strong history of dividends. Currently, the firm has a dividend yield of 2.96%, and an annual dividend of $2.25 per share. P&G has a long history of dividends, and the company has been increasing its dividend payouts on regular intervals. P&G has a payout ratio of about 60%, based on free cash flows. In the past twelve months, the company paid cash dividends of $6.3 billion and generated free cash flows of $10.7 billion. In order to assess the dividend sustainability of the company, I take a deep look at the free cash flows and some important metrics.
Free Cash Flows
Free Cash Flows
Depreciation and other noncash charges
Funds from Operations (FFO)
change in noncash current assets
change in noncash current liabilities
Operating Cash flows
Free Operating Cash Flow
Source: SEC filings
In the previous three years, the company has experienced a decrease in its net income. The same pattern is evident in funds from operations and cash flows from operations of the company. The cash flows from operations have significantly deteriorated and currently stand at $13.2 billion, compared to $16 billion at the end of 2009. P&G invests a substantial amount of capital in the business, and in each of the previous three years, the amount of capital expenditures has remained above $3 billion. At the end of 2009, the firm spent $3.067 billion in capital expenditures; however, by the end of fiscal 2012 the capital expenditures for P&G had gone up to $3.9 billion.
The company generates healthy free cash flows. Although, the capital expenditures have been increasing the firm has been able to post impressive free cash flows. However, the trend in free cash flows has not been impressive over the past three years. Free cash flows for P&G have come down substantially from the levels of 2009. At the end of 2012, the company reported free cash flows of $9.3 billion, significantly less than $13 billion reported at the end of 2009. However, cost cutting measures have helped the cash flows of the company, and trailing twelve months free cash flows have improved. Free cash flows for the past twelve months stand at $10.6 billion for P&G.
Funds from Operations(FFO)/Total Debt
FFO/Capital spending requirements
Free Operating Cash Flow + interest expense/ Interest expense
Debt Service coverage
For my analysis, I have used four ratios. First ratio indicates that the debt of the company is adequately covered with the FFO. The ratio has shown a downward trend over the past three years. However, I believe the FFO to debt ratio will be better for the current year, due to an increase in earnings and cost cutting measures. The firm is generating enough cash flows to cover the long term debt. The second metric indicates that one of the most important components of the firm is easily covered with the FFO of the company. As I mentioned, capital expenditures are an integral cash outflow for P&G, and the analysis shows that the firm is able to meet its capital spending requirements through its internally generated funds.
Last two metrics in the table indicate that the firm is able to meet its interest and debt payments sufficiently. Procter and Gamble has high levels of debt, and the debt levels have remained fairly stable over the past three years. The company reported long term debt of just over $21 billion at the end of fiscal 2012. Furthermore, the debt service coverage ratios are solid for the company. These ratios indicate that the company does not face any immediate threat from its high levels of debt.
P&G has been suffering due to a number of factors. However, the company has been able to continue its tradition of increasing dividends. I do not believe the dividends of this giant are currently under any threat. Furthermore, earnings are improving for the company due to cost cutting efforts. As a result, free cash flows have improved. A continued increase in free cash flows will bring the payout ratio down for the company, and allow it to continue increasing dividends on a consistent basis.