Procter & Gamble: Expect A Dividend Yield On Cost Of 3.7% In 2 Years

| About: The Procter (PG)


Free cash flow will likely grow by above 5% CAGR in the next few years.

Continued share buybacks will help sustain a 7% dividend per share CAGR with both free cash flow and earnings dividend payout ratios being steady.

The next 2 dividend hikes may come in at ~7%, and yield on cost could reach 3.7% by mid 2016.

Procter & Gamble's (NYSE:PG) dividend has grown by a healthy 7.5% CAGR since 2011. The most recent dividend hike in April 2014 came in at 7.0%. Given that PG is a typical blue-chip dividend stock, its future dividend trend would be essential for an investment decision. In this article, I will provide readers some perspectives on the company's future cash flows and dividends.

I have performed free cash flow projections to gauge the company's capacity for dividend growth. Given PG's fairly steady operating cash flow margin in the past 3 years, my analysis was based on consensus revenue estimates, which predict the top line to grow by 3.4% CAGR from $84.1B in fiscal 2014 to $90.0B in fiscal 2016. I assumed a 16.5% operating cash flow margin for fiscal 2014, which is consistent with its 3-year historical average. As consensus view expects about 100 bps EBITDA margin expansion from fiscal 2013 to fiscal 2016, I assumed the cash margin to rise by 50 bps from fiscal 2014 to 2016, which is more conservative than the market's view. For capital expenditure, I used consensus estimate of $3.8B for fiscal 2014 and assumed the figure to reach $4.0B by fiscal 2016. Based on the somewhat conservative assumptions, free cash flow was projected to grow by 5.8% CAGR from $10.1B in fiscal 2014 to $11.3B in fiscal 2016 (see chart below).

Based on fiscal annual dividend of $2.45 per share for 2014 and my share count estimate (discussed later), PG is expected to spend about $6.7B on the common dividend in fiscal 2014. This would suggest the free cash flow dividend payout ratio will increase from 58% in fiscal 2013 to 66% in fiscal 2016. Assuming dividend spending to grow by 6% per annum in fiscal 2015 and 2016, the figure would reach $7.5B by fiscal 2016, while the free cash flow payout would remain steady thanks to my 5.8% free cash flow CAGR forecast. In this case, the company will have $3.4B-$3.8B excess free cash flow in each year that can be used to fund share buybacks (see chart above).

For share repurchase, I incorporated a scenario that PG will spend $6B in fiscal 2014 (in line with management's guidance of $5B-$7B) and use 90% of the excess free cash flow in fiscal 2015 and 2016. This is a somewhat conservative scenario, as I believe management will likely spend more than the excess free cash flow in fiscal 2015 and 2016 on share buybacks given their commitment to returning capital, and the extra funding will come from exiting cash or additional debt borrowings. Based on an average buyback price assumption of $80 for fiscal 2014 and 7.5% growth rate in the following 2 fiscal years, I estimated that average share count will drop below 2.70M by fiscal 2016. Hence, the dividend per share was projected to grow by 7.1% CAGR from $2.45 in fiscal 2014 to $2.81 in fiscal 2016. Comparing with consensus EPS estimates, my dividend forecasts imply that earnings dividend payout ratio will decrease slightly from 58% in fiscal 2014 to 57% in fiscal 2016 (see chart below).

Given that 1) both my projected free cash flow and earnings payout ratios are stable over the forecast period; 2) the company's consensus long-term EPS growth estimate of 8.4% is above my dividend per share growth forecast; and 3) some conservative assumptions were incorporated in the analysis, I believe PG can comfortably sustain a 7% dividend per share CAGR at least over the next few years.

The chart below shows a quarterly breakdown (on a calendar year basis) of my fiscal annual dividend per share forecasts. From now to fiscal 2016, I expect 2 dividend hikes in Q2 2015 and Q2 2016 (on a calendar year basis) at about 7%. The quarterly dividend may reach $0.74 by Q2 2016, which implies a yield on cost of 3.7% based on the current share price of ~$80. It is noted that PG's dividend yield has rarely reached this level in the past, indicating a solid margin of safety.

Based on current annualized dividend (forward basis) of $2.58 and 9% cost of equity, the Gordon Growth Dividend Discount Model suggests that the current price of ~$80 has priced in a dividend growth rate of less than 6%. Hence, from an income perspective, PG is worth considering (see chart below).

All charts are created by the author, and historical data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.

Disclosure: The author is long PG. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.