Procter & Gamble (PG) has been aggressively restructuring its leadership pool this year. Last month, the company again announced it will have new people in vital management positions by first quarter of 2014. Procter & Gamble also made changes to its global leadership team last June.
CEO Bob McDonald decided to retire from Procter & Gamble last May and was replaced by former CEO A.G. Lafley. These major management adjustments were mostly caused by activist PG investors like Bill Ackman who called for a change to how the stagnant consumer goods company should be managed. Ackman has agitated for Procter & Gamble to adapt new tactics to stop its declining sales growth. PG has lagged behind Unilever (UL) in terms of revenue growth despite it being smaller.
Cost-Cutting Measures Are Not Enough
Despite the initial successful implementation of his 5-year $10 Billion cost savings and productivity program, Bob McDonald still failed to satisfy big investors like Ackman. Due to the sub-par sales performance of PG for the first two quarters of 2013, McDonald had no choice but to retire to appease disgruntled big investors.
Procter & Gamble is facing strong headwinds - sluggish growth in emerging markets which is predicted to linger like so for the long term due, and stagnant sales in major countries. The $10 Billion cost-cutting plan was intended to increase or maintain gross profit margin of the company. It doesn't really offer any substantial strategy to improve the meager revenue growth rate of PG.
High Dividend Payment is a Handicap
I know value investors love a dividend cash cow like Procter & Gamble. The company has paid dividends to shareholders since for the last 120 years or so. While PG's price only increased by 74% for the last 10 years, the company kept giving investors ever-increasing dividend yields. From $4.5 billion in 2008 to the $6.5 billion of 2013, Procter & Gamble continuously increased its dividend payments despite its low net income performance.
While shareholders enjoy this dependable high yield, it is actually handicapping Procter & Gamble. Its revenue and net income are not keeping up with the rate of increase in dividend payments. For the last 25 years, PG has managed to give investors an average of 10.85 dividend growth rate. This year, PG management trimmed its target dividend increase yield to 6% - 7%, acknowledging a prudent growth estimate for the next five business years.
Despite the lower annual increase rate of dividend payment, I still believe that this huge payment to shareholders is a major obstacle to Procter & Gamble's future prospect. For this year, as of June 30, Procter & Gamble made a net income of $11.31 billion. Out of this amount, the company is giving $6.5 billion to shareholders as dividend payouts.
The dividend payment to net income ratio is 57% which is just too high for comfort. It is most probably unsustainable considering the unfavorable market conditions. If industry observers are to be believed, consumer goods companies like Procter & Gamble will have a difficult time hitting a 7% annual growth rate for the next five or ten years.
Stiff competition, global recession, cheaper local alternatives in emerging markets, these are just a few reasons that can adversely affect the future profitability of Procter & Gamble. How can it afford to pay a 7% annual increase in dividend yield against these serious headwinds? If the company fails to adjust its policy, it will be spending all its annual profit to satiate dividend-centric stockholders.
Reinvest More Income
The new management of Procter & Gamble should risk shifting gears. I believe that adopting a new strategy that lowers the dividend payments and using the money instead to improve the business, will be more beneficial in the long run. Short-term pain for a long-term gain.
Investors accustomed to enjoying a high dividend yield are expected will most likely resist this move. The new leaders of Procter & Gamble, if they are really serious in developing a better plan for the future of the company, should also be persuasive enough to convince stakeholders that lowering the dividend payments is for their benefit. Low dividend payments mean more money for the management to use for sourcing out new opportunities.
The company has several iconic brands like Tide, Ariel, Gilette, Duracell, Head & Shoulders, Pantene, Wella, and Vicks. Each of these products, bring generate more than a $ 1 billion in sales. Right now, the greater part of the profits from these products are not being used to grow the company. Nothing lasts forever, these brands will not remain cash-cow machines for 124 more years. The income they generate now ought to be spent in creating replacement products.
I'm not going to buy any new Procter & Gamble shares unless the new management changes their approach on how to use the huge net profits. More income should be spent on growing the business to insure the future viability of the company.
I'll buy lots of PG stocks if the dividend payment is around 30% of net income.