Procter & Gamble: Growth Beyond Buybacks?

Dec.25.13 | About: The Procter (PG)

In 2008, the Procter & Gamble (NYSE:PG) company made $12.07 billion in net profits for shareholders. By the end of 2013, Procter & Gamble is on pace to make $11.86 billion in net profits. Despite this modest decline in total profits over the past five years, the earnings per share for shareholders has increased due to a modestly aggressive buyback program that has reduced the share count from 3.03 billion in 2008 to 2.74 billion by the end of 2013 (if you see stock screeners that report the number of shares outstanding as higher than that, it is because they use a weighted average model to perform their calculations, rather than regularly updating the actual raw amount of shares actually in existence).

Because of this reduced share count, the earnings per share for Procter & Gamble shareowners has actually increased from $3.64 per share in 2008 to $4.05 per share in 2013. This 11.26% per share growth in per share profits has been fueled entirely by a declining share count, as Procter & Gamble is currently a little bit less profitable than it was in 2008.

As shareholders, there are two questions worth considering: Will the buybacks continue? And will the company be able to accompany actual honest-to-god profitability growth on a companywide basis, in addition to the buybacks?

The answer to the first question seems to be yes. Since 2006, Procter & Gamble has been committed to taking somewhere between 10 and 50 million shares off the market each year. They have been able to do this by keeping the dividend at around half of profits, and using the remaining free capital that does not need to be reinvested to go towards reductions in the share count. In November, P&G indicated an intention to buy back between $5 and $7 billion worth of stock, which ought to account for 2-3% annual growth in the earnings per share figure.

From there, it is just a question of trying to figure out Procter & Gamble's organic profitability rate going forward. When you add up the earnings results from the Beauty, Grooming, Health Care, and Fabric Care segments (which account for 81% of earnings), you are finally starting to see volume growth without the accompaniment of lower prices. From 2010-2012, Procter & Gamble had to lower prices in those four segments to maintain its volume output (although there were a few quarters in the past three years when it declined modestly).

But now, Procter & Gamble is finally achieving 4-5% overall volume growth from those four segments without having to lower prices to do so. That is why I think that Procter & Gamble's earnings growth problems of the past few years have finally reached an inflection point; this is the first time since 2007 shareholders are finally starting to see organic volume growth that is not artificially stimulated by lowering the prices of Procter & Gamble's goods at the four segments mentioned above that are responsible for most of P&G's earnings.

Additionally, P&G is cutting about $220 million in costs every four to five months or so, which is the kind of thing that adds a percentage point or so to the profits that reach shareholders.

For the past five years, the growth at Procter & Gamble (in terms of earnings per share) has been solely courtesy of the stock buyback program that reduced the share count from a little over 3 billion to 2.74 billion. But now, that 3-4% earnings per share growth due to buybacks is finally showing signs of being accompanied by organic profitability growth; the 4-5% gains in volume (without price declines) seems likely to add another 4% or so to the growth in earnings per share figures. When you mix that in with the modest continued cost-cutting, it seems that Procter & Gamble has finally turned the page from 4% annual growth in earnings per share to something in the ballpark of 8%. That's good news because it provides room for high single-digit dividend increases going forward, and it signals that Procter & Gamble's growth is finally on track. Meaningful volume growth without price decreases is something that P&G shareholders haven't seen in a while, and its return should portend good things to come for long-term shareholders.

Disclosure: I am long PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.