The Procter & Gamble Company (PG) is focused on providing branded consumer packaged goods. The company sells its products in over 180 countries through retail operations, including mass merchandisers, grocery stores, membership club stores, drug stores, department stores, salons, and high-frequency stores.
P&G is currently yielding a healthy 3.6% dividend yield, approximately double the current yield on the 10-year U.S. Treasury bond. Furthermore, the stock has delivered consistent growth in its dividend, based on the historical dividends shown below:
Looking at P&G's free cash flow over the same time period, we see that it has slowed considerably. During most of the past ten years, it was posting strong, double-digit growth in FCF/share. Over the past three years, however, it has been a challenge for the company to continue to grow this metric.
Additionally, the dividend-to-free cash flow per share payout ratio has jumped, though it is still relatively low (under 40%) for such a mature company. Although, if the company is able to continue growing FCF/share at a high single-digit, that should provide a stream of cash to fund dividend increases.
|Year||FCF/Share||Payout Ratio (Div / FCF per Share)|
In April, P&G raised its quarterly dividend 7%, marking the 56th consecutive year the company has increased its dividend. In addition, the recently announced divestiture of P&G's snack business to Kellogg Company should also provide cash to pay down debt and help fund dividend growth.
Dividend Discount Model
In performing this valuation, I made several assumptions. First, I used 9% as my discount rate, based on the long-term average return of the stock market. Second, I used P&G's 7% quarterly dividend increase to set the dividend growth rate for 2012. I used a constant growth rate of 9% for years 2013-17, an 8% growth rate for 2018-19, and 7% for years 2020-22. Finally, I assumed a 5% perpetuity rate after 2022.
Based on these assumptions, I calculated that P&G's intrinsic value is $73.06 per share. At the current price, the stock is ~15% below its intrinsic value and provides a decent margin of safety for a blue chip stock. The market is pricing P&G's dividend growth rate into perpetuity at ~5.5%, which I believe is low considering its historical dividend growth rates.
Proctor & Gamble is a low volatility stock with a history of steady dividend increases, but limited upside in terms of price. Therefore, long-term, income-oriented investors may want to give P&G a closer look to see if it should be included in their portfolio.
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