The share price of Procter & Gamble (PG) has risen by 24% over the past 12 months. At $78.82, the stock is trading near its 52-week high of $82.54- just reached in last month- and offers a 3.1% dividend yield. Despite the notable price appreciation, I believe investors can still consider buying this solid dividend stock at the current price level. My view is based on the following 5 reasons:
1. PG shares are reasonably valued relative to its comparables. According to the table shown below, PG's consensus revenue, EBITDA, and EPS growth estimates underperform the comps averages. On the profit side, however, PG demonstrates a better performance as its various profitability margins are above par. But the firm's ROIC metric is below the peer average. In terms of leverage and liquidity, PG's debt load is fairly in line with the comps given its lower debt to capitalization ratio, but higher debt to EBITDA multiple. PG's free cash flow margin is above par, but its interest coverage ratio is below average. Both the company's current and quick ratios are below averages, reflecting a relatively mediocre balance sheet condition.
The stock's current price multiples at 12.4x forward EBITDA and 18.7x forward P/E (next 12 months) are on average 8% below the peer-average trading multiples. As PG's growth potential is relatively weaker than the comps, such a valuation discount appears to be fair. Further, after accounting for the 5-year earnings growth estimate, PG's PEG ratio of 2.2x is on par with the group average, which is supported by the firm's better margins, below-average capital return, and in-line liquidity condition (see chart above).
2. From a historical valuation standpoint, one would likely draw a similar conclusion. PG's trailing P/E multiple is currently trading modestly above its 5-year historical average (see chart below).
The higher valuation can be justified by the following fundamental developments over the 5-year period:
1) PG has been able to drive up the return on invested capital and assets over the past 5 years (see chart below);
2) The company has also been able to maintain steady profitability margins and slightly improve the free cash flow margin (see chart below); and
3) Although PG's revenue and EBITDA growth rates slowed down modestly in recent years and its EPS growth rates dropped significantly, the consensus estimates for the current and next 2 fiscal years are showing a recovery (see chart below).
3. The trailing P/E multiple gap between PG's and that of S&P 500 Index has narrowed since 2013 and is currently at just 4.8% (see chart below).
The slight market premium is fair or even somewhat attractive provided that 1) PG's consensus 5-year earnings growth estimate at 8.6% is in line with the average estimate of 8.2% for the S&P 500 Index; 2) the stock offers a higher dividend yield at 3.1% over the 2.5% average yield for the S&P 500 Index and the share price is supported by the company's share buyback program; and 3) PG's significant company size and global reach should warrant a valuation premium.
4. PG's dividend yield and its growth prospect will provide a solid cushion to the stock price. Since 2010, the company has raised the dividend per share for 4 times by 9.5%, 8.9%, 7.0%, and 7.1%, consecutively. Given PG's healthy free cash flow margin and the fact that the firm's annual free cash flow was more than sufficient to cover the total dividend payment in the past few years (see chart below), I believe the current pace of the dividend growth is sustainable at least in the near term. Moreover, as demand for dividend investments remains strong amid the current low-interest market environment, a significant increase in PG's dividend yield would be unlikely.
As such, assuming a target yield range from 3.0% to 3.5 (this assumption is supported by PG's historical yield range (see chart below) post financial crisis), and supposing that the annualized dividend per share would be raised by 6.5% from the current $2.41 to $2.56 in the April 2014 payment period, this conservative scenario would yield a stock price ranging from $73.3 to $85.5, or a fairly balanced return band from -7.0% to 8.5% even without considering the 3.1% dividend income generated in the holding period.
5. In a Morgan Stanley research note released on April 29, Dara Mohsenian commented on a few positives for the stock which I tend to believe in (sourced from Thomson One, Equity Research):
Despite our topline worries, we do think PG's stock is starting to look more compelling. First, PG's relative valuation has become more attractive given PG has had the worst YTD performance among our large cap coverage (-400 bps vs. peers). Second, cost-cutting is ramping up (and emerging markets profit growth is rebounding with more normalized spending), which should drive profit/EPS growth even if topline trends remain weak. Last, despite a Q3 topline disappointment, we do believe Q3 is likely the bottom in organic sales growth as a recent pronounced marketing ramp-up in Q3 (which we expect to continue in Q4) should drive demand, and recent U.S. innovation (which has driven a U.S. share rebound) expands globally.
Bottom line, in the light of PG's healthy fundamentals, sustainable dividend yield, and inexpensive valuation, this quality dividend stock should definitely be worth a look.
Disclaimer: All charts are created by the author and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.