Procter & Gamble: Low Risk, Slower Dividend Growth Ahead

Jan.16.14 | About: The Procter (PG)

Procter & Gamble (NYSE:PG) has a yield right around 3% which is more than 1.5x the yield of the S&P 500 (NYSEARCA:SPY) and in line with the 10-year government bond (2.9% yield). While historically investors have enjoyed high single digit dividend growth, the expansion in the payout ratio indicates the dividend growth rate will need to be pulled back some or the Company will have to catch up through earnings growth. Given the consensus estimates, the latter will prove difficult.

I. COMPANY OVERVIEW

Procter & Gamble Company is focused on providing consumer packaged goods. The Company's products are sold in more than 180 countries and territories worldwide primarily through mass merchandisers, grocery stores, membership club stores, drug stores, department stores, salons, e-commerce and high-frequency stores, and the neighborhood stores, which serve many consumers in developing markets. The Company has 25 billion dollar brands and has raised its dividend for the last 57 consecutive years.

II. HISTORICAL PERFORMANCE

  2009 2010 2011 2012 2013
Revenue $76,694 $77,567 $81,104 $83,680 $84,167
% Growth n/a 1.1% 4.6% 3.2% 0.6%
Gross Profit 38,004 40,525 41,245 41,595 42,095
% Margin 49.6% 52.2% 50.9% 49.7% 50.0%
EBITDA 18,456 18,840 18,333 19,124 18,727
% Margin 24.1% 24.3% 22.6% 22.9% 22.2%
Net Income 13,436 12,736 11,797 10,756 11,312
Avg Diluted Shares 3,154.1 3,099.3 3,001.9 2,941.2 2,930.6
% Growth n/a -1.7% -3.1% -2.0% -0.4%
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Note: All figures are MM's (except per share data) unless noted otherwise

Procter & Gamble has been relatively flat over the past five years. The Company's revenue expanded every year since 2009 at a compounded annual growth rate of 2.4% (more or less inflationary growth). The gross margin has trended positively while also staying within a tight 2.7% range over the past five years (bottoming at 49.6% and peaking at 52.2%). On the other hand, EBTIDA Margins have contracted from 24.1% in 2009 to 22.2% in 2013 with the net result of EBITDA expanding from $18,456MM in 2009 to $18,727MM in 2013 (1% expansion) over the five year period.

Per Share Data
  2009 2010 2011 2012 2013
Revenue $24.32 $25.03 $27.02 $28.45 $28.72
% Growth n/a 2.9% 8.0% 5.3% 0.9%
Gross Profit 12.05 13.08 13.74 14.14 14.36
EBITDA 5.85 6.08 6.11 6.50 6.39
Net Income 4.26 4.11 3.93 3.66 3.86
Dividends 1.64 1.80 1.97 2.14 2.29
Payout Ratio 38.5% 43.8% 50.1% 58.4% 59.3%
Dividend Growth n/a 9.8% 9.4% 8.5% 7.0%
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Note: Per share data based on weighted average diluted shares outstanding.

On a per share basis, we need to view the Company wide historical performance in a different light. The Company has changed their weighted average shares outstanding through share redemption from 3,154MM to 2,931MM over the period (a 7.1% decrease) resulting in a more favorable performance on a per share basis. EBITDA per share has expanded from $5.85 to $6.39 (a 9% increase as compared to a 1% increase at the Company level). The Company's dividends per share have been growing, increasing from $1.64 per share in 2009 to $2.29 per share in 2013 (a 39% increase or a 8.7% compounded annual growth rate) while the payout ratio has increased from 38% to 59%.

III. CAPITALIZATION

  Market / Par Value EBITDA Multiple
- Cash and Equivalents $7,702 0.4x
+ Total Debt $34,780 1.8x
+ Minority Interest $729 0.0x
+ Market Capitalization $219,606 11.5x
Total Enterprise Value $247,413 12.9x
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Note 1: Based on TTM EBITDA of $19,117MM as of 9/30/13.

Note 2: Market Cap based on 2,718.2MM shares outstanding and a $80.79 market price as of 1/15/14.

Procter & Gamble has an under leveraged capital structure. The Company is levered at 1.8x TTM EBITDA (1.4x net of cash) with a total enterprise value of 12.9x TTM EBITDA. Ideally, the Company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage the Company would have a low cost of debt and maintain significant financial flexibility while enhancing returns to the equity holders. With 25 billion dollar brands consumer goods brands the Company could take out quite a bit more debt and still maintain a good credit rating.

IV. PROJECTIONS

  2014 2015 2016 2017 2018
EBITDA $20,047 $21,189 $22,526 $22,526 $22,526
% Growth 7.1% 5.7% 6.3% 0.0% 0.0%
Interest Expense 660 660 660 660 660
Taxes 3,688 3,907 4,163 4,163 4,163
Capital Expenditures 4,119 4,353 4,628 4,628 4,628
Dividends 6,540 6,540 6,540 6,540 6,540
Addl' FCF $5,039 $5,728 $6,534 $6,534 $6,534
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Note: All figures are MM's (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for Procter & Gamble are conservative projecting a growth rate between 7.1% and 5.7% annually through 2016 at the EBITDA line (projections unavailable for 2017 and 2018). Under the consensus case the Company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

  2014 2015 2016 2017 2018
Addl' FCF $5,039 $5,728 $6,534.2 $6,534.2 $6,534.2
Share Redemption Price $92.91 $106.84 $122.87 $141.30 $162.50
Shares Redeemed 54.2 53.6 53.2 46.2 40.2
Wtd Avg Diluted Shares 2,718.2 2,664.6 2,611.4 2,565.2 2,525.0
Dividends Per Share $2.41 $2.45 $2.50 $2.55 $2.59
Dividend Growth 5.2% 2.0% 2.0% 1.8% 1.6%
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The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The Company's share redemption would allow for a 2% increase in the dividend annually from the share redemptions alone. Additionally, the Company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the Company's earnings (using EBITDA as a proxy) would be increasing.

If the Company performs in line with the consensus estimates and pay dividends / redeems shares as outlined above, the Company would achieve the IRR / Cash on Cash returns illustrated below based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple
  10.4x 10.9x 11.4x 11.9x 12.4x 12.9x
IRR 2.6% 3.8% 4.9% 6.0% 7.0% 8.6%
Cash on Cash 1.12x 1.17x 1.23x 1.28x 1.34x 1.43x
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V. RECOMMENDATION

Procter & Gamble remains a good low risk investment and adequate bond substitute. Going forward, I don't think the dividend will increase like it has over the past five years (high single digits) given the expansion in the payout ratio and I think we'll see middle single digits dividend growth resulting in a high single digit total return (dividends + capital gains). Right now I don't think this is the most attractive investment opportunity, but I'm using it as a bond substitute given that I have a long investment horizon. I know among Dividend Growth Investors that Procter & Gamble is fairly widely held, what do you guys think about the future prospects?

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.