- Procter & Gamble has broken out of its slump of negligible earnings per share growth that characterized the 2010-2012 period.
- Volume shipments are finally on the rise, enabling P&G's core business to grow at a high single-digit rate.
- P&G's payout ratio has risen to almost 60%, meaning its next dividend increase will have to roughly track the company's earnings per share growth rate.
One reason why Procter & Gamble (NYSE:PG) hasn't been getting much "respect" in the past 6-12 months is because the company has experienced high one-time charges and negative currency impacts that have overshadowed the fact that the company's business model has been turning the corner for the better this year.
During the last two quarters of 2010, through 2011 and 2012, the company was stuck making up $0.96 in per share profits every ninety days. The total profit actually went down a bit in 2012, as the profits of $3.85 per share trailed the company's performance of $3.93 per share in 2011. Procter & Gamble has finally broken out of that earnings holding pattern, now that we can see that the company boosted its 2013 profit above the $4 threshold to $4.05 per share. That 5.19% growth actually understated CEO Lafley's ability to guide P&G to higher profits, as the 2013 figures contained an unusually higher number of one-time impairments for employee restructurings and other cost savings.
The question then becomes: What is Procter & Gamble doing now that demonstrates superior business performance compared to what we saw from the company during the 2010-2012 stretch?
Well, you have two things going on. First, Procter & Gamble gets a slight boost from share buybacks (it retires $1.5 billion in stock per quarter, for an annual rate of about $6 billion per year). This sounds enormous, but given that P&G is a $215 billion company, the share count usually only gets reduced by 2.5%-3.0%. But still, it's a nice little tailwind to help earnings per share figures improve.
The second thing is that Procter & Gamble can point to 2013 as a turning year of sorts: it was the first time since the end of the recession that the company was able to grow volumes without lowering prices. That's important because the 2010-2012 stretch was a time when the company employed what I call a see-saw strategy; they would raise prices, but it would result in lower volumes. Then, when they finally got volume shipments rising, it was because they lowered prices as well. In 2013, however, the company was able to actually increase volumes by 4% across its (1) Beauty, (2) Grooming, and (3) Healthcare divisions without having to lower prices simultaneously.
And volume growth tends to have an almost doubling effect on profits at P&G; the only reason why Procter & Gamble reported 5% earnings per share growth instead of 7-8% earnings per share growth in 2013 is because of negative currency headwinds and excessive restructuring charges. The core businesses have turned the corner, but other factors have prevented shareholders from seeing that benefit clearly.
That brings us to our next question: Given the business changes above, what kind of increase should shareholders experience when the company makes its usual dividend increase announcement in April?
Well, the company is currently in the position where its dividend growth rate has to match its earnings per share rate. It doesn't have room to increase its payout ratio because the company gave shareholders dividend increases in excess of earnings growth during, and throughout the aftermath of, The Great Recession. Back in 2007, Procter & Gamble was making $3.04 in profits while only paying out only $1.28 in dividends. That's a payout ratio of only 42%. But the company has spent the past six years raising the dividend faster than it has been growing profits, and now the current dividend obligation of $2.40 per share represents 59% of the company's profits, which are at $4.05 per share.
My expectation is that Procter & Gamble will give shareholders a dividend increase that falls in with core business performance, adjusted for buybacks and currency headwinds. In other words, you have a core business that is growing at 7% because the volumes are steadily inching upward at a rate of 3% per year, but it only gets reported at 5.5%-6% because of the negative currency conversion. However, there's one other countervailing force: a buyback program that is taking 2-3% of the shares off the market. That puts the company in the position of raising the dividend somewhere in the 7-9% range to reflect the company's upcoming earnings per share growth.
I think it's time to start getting excited about being a Procter & Gamble shareholder again. My premise for that belief is the fact that volumes are starting to increase without P&G having to lower prices. Volume growth plus static prices (and, in some cases, slightly increasing prices) is the elixir that allows P&G to move past its slumping business performance from 2010 through 2012. We've got a core business growing at 7-8% again, but it appears to be less due to currency conversions. Once you throw in the fact that the company is retiring shy of 3% of its shares outstanding, it seems the company ought to be in a position to raise its dividend 7-9% this April during its customary quarter of raising the payout.