Procter & Gamble: What Happened To The Dividend?

| About: The Procter (PG)

Summary

Procter & Gamble increases its quarterly dividend by just 1% to $0.6695 per share.

This is one of the smallest dividend increases ever for the company.

It appears the strong dollar and falling core EPS are to blame.

While I was expecting a disappointing dividend increase, this still caught me by surprise.

When I first read the news I could barely believe it. As the SA headline noted, Procter & Gamble (NYSE:PG) raised its dividend by a paltry 1% to $0.6695 per share. This was way below the 3-4% hike I was expecting.

Smallest dividend increase on record?

Going back over the past 10 years, Procter & Gamble's average dividend increase has been for ~9%. Over the past 5 years it has been ~7%.

The 1% increase for 2016 is the smallest one I can find on record for Procter & Gamble. To say this is disappointing would be an understatement.

PG Dividend Chart

PG Dividend data by YCharts

Why was the increase so small?

As I note in my recent article, Procter & Gamble is facing a rough 2016. While "constant currency" Core EPS was slated to grow in the mid-to-high single digits, Core EPS was expected to drop by 3-8% this year versus last. This has pushed the payout ratio to above 73%, which did not leave much room for growth.

The main factor hurting Procter & Gamble earnings is the strong dollar. The dollar has gained in value versus most currencies due to higher interest rates and a flight to safety. Given that Procter & Gamble generates the majority of revenues overseas, a stronger exchange rate is a major negative.

Given that the dividend was increased by just 1%, Procter & Gamble's new payout ratio will be ~75% of core EPS and ~64% of FCF.

As for why I was expecting a 3-4% increase, I was focusing on Procter & Gamble's free cash flow "FCF". Based on its guidance, FCF for 2016 was expected to stay flat y/y.

Given that the dividend represented ~63% of FCF, I felt there was more room here for growth than there apparently was. It may be that Procter & Gamble FCF guidance was too optimistic and may be revised lower.

Or the company is simply does not have enough cash since it is also focusing on buying back. Procter & Gamble plans to buy back $8-9 billion in stock this year. Backing out the Duracell transaction, this represents ~$4.5 billion in cash needs.

With FCF estimated to be ~$11.6 billion, this leaves ~$7.1 billion for dividends. At the new quarterly rate, Procter & Gamble's dividend is using up $7.23 billion in cash per year, resulting in an "all in" payout ratio slightly above 100%.

Conclusion

The 1% dividend increase from Procter & Gamble is frankly unacceptable for dividend-growth investors. Even income stocks like AT&T (NYSE:T) and Verizon (NYSE:VZ) offer higher yields at 4.3% and 5.0%, and growth, 2% and 3%, versus the 3.2% yield and 1% growth for Procter & Gamble.

Keeping an open mind, Procter & Gamble is simply being prudent. The company obviously does not want to increase its dividend without corresponding earnings and FCF growth. The 1% raise was more of a token increase, to keep the annual streak going, rather than an indication of a trend.

Nevertheless, I am now thinking about selling Procter & Gamble. I will wait of course to see if they can turn things around. I'll give them another year. They are one of the biggest losers when it comes to the strong dollar and weakness in the key Latin American currencies. This is a headwind completely out of their control. Though, if things deteriorate, say they have operational issues, then I'll have to sell my holdings.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

Disclosure: I am/we are long PG, T.

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.