Shares of Procter & Gamble (PG) saw a slight uptick in after-hours trading on Monday after analysts at Wells Fargo Securities issued some upbeat comments on the prospects for the firm.
I agree with Wells Fargo that Procter & Gamble is taking the right steps at the moment. I think shares are a perfect addition to any long-term investment portfolio focused on capital gains and fair dividend yields. Yet I am not sure if the annual meeting, or the first-quarter results could act as a short-term catalyst.
Wells Fargo Is Positive
Analyst Chris Ferrara, upgraded Procter & Gamble from "Market Perform" to "Outperform." The price target for the firm was raised from $80 to $86, suggesting nearly 14% upside potential from current levels.
Key obstacles that remain are the premium positioning in both the U.S. and Europe, as well as low margins in developing markets. Yet productivity momentum, improving market share, and a focus on developing markets' profitability should drive execution.
Ferrara sees a positive risk/reward trade off helped by a 3.2% dividend yield and consistent 90-100% free cash flow conversion.
Back in August, Procter & Gamble released the full year results for its fiscal year of 2013. The company ended its fiscal year of 2013, with $5.95 billion in cash and equivalents. Total debt stood at $31.54 billion, for a net debt position of roughly $25.5 billion.
Full year revenues came in at $84.2 billion, up a percent on the year before. Net earnings increased by 5% to $11.4 billion.
Trading around $76 per share, the market values Procter & Gamble at some $207 billion. This values equity in the firm at 2.5 times annual revenues and 18 times annual earnings.
Procter & Gamble currently pays a quarterly dividend of $0.60 per share, for an annual dividend yield of 3.2%.
Some Historical Perspective
Over the past decade, shareholders have seen fair returns. Shares have traded in a $50-$80 trading range, currently trading at the high end of that range. On top of that came a fair dividend yield, currently yielding 3.2% per annum.
Between its fiscal 2010 and 2013, Procter & Gamble increased its annual revenues by nearly 9% to $84.2 billion. Net earnings fell by 12% in the meantime to $11.3 billion. The company retired nearly 5% of its shares outstanding over the past three years, to offset the impact on earnings per share.
Investors are relieved that CEO Alan Lafley has returned to become CEO of Procter & Gamble again earlier this year, replacing Bob McDonald, who was axed after disappointing performance. Last year hedge fund investor Bill Ackman bought a $1.8 billion stake in the company, urging the board to replace its key executive. Under command of McDonald, Procter & Gamble has made few bold moves, while Lafley historically made such moves, including the $57 billion deal with Gillette back in 2005.
In recent years, the company has been hit by the recession given its premium positioning, poor new product development and costly expansion in international markets. This has taken a toll on notably margins, as earnings were falling despite modest revenue growth.
Lafley now has the difficult task to restore growth without sacrificing earnings too much. Lafley immediately called 2014 a "transition" year, yet operations are expected to show growth this year. Core earnings for 2014 are seen up by 5-7% per share, including a full 6 percentage points hit from adverse currency movements. Sales are seen up by 3 to 4% for the coming year.
Procter already cut production and marketing costs under the helm of McDonald, a move which has shown some early success over the past quarter, as demonstrated by market share gains and better sales results. Some 20 months ago, in February of 2012, P&G announced a $10 billion restructuring program. By now some 7,000 workers have left the company, ahead of schedule.
With revenue growth showing promising signs again, it is key to boost margins to more attractive levels. I think revenue growth from $84 billion last year to $90 billion in 2015 should be possible. If net margins could recover to 15%, earnings should be able to improve to $13.5 billion, resulting in a price-earnings ratio of 15 times earnings.
This looks reasonably solid for a quality name like Procter & Gamble, which has weathered more serious storms compared to the issues over the past years. At least Lafley is supporting shareholders in the transition process, paying out $6.5 billion in dividends and $5-$7 billion in share repurchases. These combined payouts of $12.5 billion imply that P&G is paying out all of its earnings at the moment to shareholders, which receive a combined yield of about 6% at the moment.
So let's see what P&G will provide us with on Tuesday at the annual meeting and at the first-quarter results, scheduled on the 25th of this month. I believe the strong payouts should be able to support the current valuation, until real improvements materialize in the coming years. Solid revenue growth and a price-earnings ratio of 15 or less in two years' time, should then support the valuation as the payout ratio drops below 100%. The ongoing impact of the cost savings, should continue to boost profitability going forward from this point in time.
I remain cautiously optimistic on the long term, for this high-quality dividend paying name.