In my recent article published on 3/26/2012, which was the Consumer Staples installment of my "Yield, Value, Safety" series, I had identified Procter & Gamble (PG) as a desirable holding, based upon the first-pass review presented in the article. I also noted that it was a stock I owned. The company has been in the financial news lately, and not in a good way. In this article I will review these recent events, and then take another look at the stock from several perspectives. My goal is to determine whether the current weakness represents a buying opportunity, or if something more serious is going on, which might indicate that more shares should not be purchased, and that instead I should consider selling.
Summary of Recent Developments
The stock had a nice run to the upside beginning in February of this year, as plans were announced regarding a new cost-cutting initiative, with a goal of reducing expenses by $10 billion over the next five years. The plan included elimination of some 5,700 positions. After moving up from $62.50 or so to $67.00 and change in less than a month, the stock held at the new level for a couple of months, then dropped precipitously at the end of April, losing nearly $4.00 in two days, after reporting disappointing earnings for the quarter ending 3/31/2012. The disappointment was compounded by reduced guidance issued coincident with the earnings report.
The stock has mostly continued to lose ground since then, with another big drop occurring on 6/20/2012, which took the stock down below $60.00, a level where it has seldom been since climbing out of the abyss along with the rest of the market in 2009. The catalyst for the second drop was an earnings warning from the company regarding the upcoming quarter, with EPS expected to be in the $.75 to $.79 range instead of the previously estimated $.79 to $.85 range. Further, the revenue outlook was lowered, and the expectations for fiscal year 2013 profit growth are now flat to mid-single digits, at best. Note that the fiscal year 2013 for Procter & Gamble begins on 7/01/2012. After digesting all of this information, the obvious question is, does this drop represent a buying opportunity, or is there something seriously wrong here?
Granted, times are tough, consumer brand loyalty is not what it once was, and competition is fierce, but there is nothing much new in those observations. Peers such as Colgate Palmolive (CL) and Unilever (UL) seem to be coping with this environment successfully. The CEO of Procter & Gamble was recently named to Jim Cramer's CEO "Wall of Shame" on a recent Mad Money episode, in which Mr. Cramer made it clear where he placed the blame. Whether the CEO is really to blame or not, when performance lags, the spotlight turns towards the top executive.
As a shareholder, I am concerned when a company I am invested in seems to be losing ground. Still, when I consider the record, over 100 years of dividends, and a string of 55 years of steady dividend increases, I can't get too worked up over the recent events. It takes time to turn around a ship this big, and the initiatives announced in February tells me that management had recognized that the firm needed some restructuring, and hopefully plans are being executed to address the situation. So I am a long way from being ready to hit the panic button. In the remainder of this article, I will review Procter & Gamble from several perspectives, to see if my apparent complacency represents an appropriate response to meaningless "noise" in the long run scheme of things, or perhaps indicates that I am ignoring wailing sirens and a dark sky that should not be ignored, something that an "Okie" should never do. Note that for the remainder of this article, the terms Procter & Gamble and PG are synonymous.
Procter & Gamble is a huge company, with a market capitalization of $163 billion, 129,000 or so employees, and over 2.7 billion shares outstanding. Headquartered in Cincinnati, Ohio, the firm is classified in the GICS system as Consumer Staples, Household Products. The companies' website (link provided to Investor Relations page) states that the firm is organized by product type into five divisions, which are Beauty, Grooming, Health Care, Fabric and Home Care, and Baby and Family Care. The CEO, Bob McDonald, assumed the post in July 2009. The latest annual report (available from the Financial Reporting selection on the Investor Relations page) states that he has over 30 years experience in the field, although it is not clear if all of that was with PG. As noted, the company has paid dividends for over a century, with a string of 55 years of increases posted, the last one being on 4/25/2012. The dividend amount is $.562 per share, which results in a yield of about 3.7%. This is a dividend record that no CEO wants to see ended on his watch.
Revenue and Profitability
As noted above, the most recent quarterly results, for the period ending 3/31/2012, were the catalyst that triggered the most recent swoon in the shares. Reviewing the most recent five quarters of revenue and net income, the most recent quarterly results did indicate a minor setback, as revenue came in slightly above the corresponding year-ago period, but net income came in slightly less. Poor fellows, only $2.4 billion of net income for the recent quarter to show for all of their hard work! Note that the upcoming quarter end on 6/30/2012 will complete fiscal year 2012 for PG, with a new fiscal year 2013 starting 7/01/2012.
While the current margins shown on MSN Money are a little under the five-year averages for the firm, the investment returns of 14.25 for ROE, 7.1 for ROA, and 8.9 for ROIC are excellent. It is not clear to me whether these figures are for the most recent quarter, the most recent fiscal year, or for the most recent 12 months, but they are decent numbers, whatever period they apply to. Looking at ten years of revenue and net income data, PG presents a picture that is about as good as it gets for such a gargantuan enterprise, with steady increases year after year. Granted, this data represents the past, as the most recent full year reported was for the fiscal year ending 6/30/2011. The next annual 10K, which should be available in early August, will need to be scrutinized carefully, but at this point, there certainly is no reason to bail on PG. The most recent quarter just wasn't that bad, Cramer notwithstanding.
As noted under General Information, above, Procter & Gamble is a dividend stalwart. The firm is a long-time component of the S&P Dividend Aristocrats, David Fish's Dividend Champions, Mergent's Dividend Achievers, and probably any other list of dividend stocks that exists. The stock is also on a select list of stocks passing a rigorous screen from Investment Quality Trends, a dividend-focused stock advisory newsletter that has been publishing since the 1960s. A recent article on MarketWatch by Mark Hulbert that was very complimentary towards the newsletter can be seen here. Note that the article title, "How not to pick a high-yielding stock," does not refer to the newsletter's methodology, but rather refers to other methods, which after discussing and pointing out various flaws, he then contrasts with the newsletter's approach, as illustrative of a better way. Finally, PG is a holding in one of the portfolios presented by the Morningstar Dividend Investor, edited by Josh Peters. I have mentioned this publication before as being my favorite stock advisory subscription service.
Financial Position and Debt
The MSN Money website data for PG shows Leverage Ratio as 2.1, Debt to Equity Ratio as .51, Interest Coverage as 16.9, and the Dividend Payout Ratio as 62%. Looking at the balance sheet from the most recent quarterly filing, I calculate the ratio of Long-Term Debt to Total Capitalization as 15.8%, the ratio of Stockholder's Equity to Total Capitalization as 48%, and the ratio of Total Liabilities to Total Capitalization as 51%. While I would prefer that the Equity ratio exceeded 50%, and that the corresponding Total Liabilities ratio was less than 50%, and also that the Dividend Payout ratio was under 60%, none of these numbers is far enough out-of-line to really be of concern. The corporate debt ratings of AA- from S&P and Aa3 from Moody's, both well into the investment grade ranges, provide further comfort regarding PG's debt position.
Valuation and Technicals
PG is not into a price range where it could be considered a true value stock. In the case of PG, value is relative - it is a better value now than it has been since the financial crisis of 2008, when it hit a low of around $43. By the standards of those days, PG was a stock that held up very well during the period. As noted in the first paragraphs of this article, PG has come down from the $66 to $67 range in the February-March time frame, to the $60 to $61 range currently. Thus, while not in "value stock" territory, the valuation metrics are a little better now than when PG was profiled in my March "Yield, Value, Safety" article mentioned in the opening paragraph above. Specifically, the present valuation metrics, and for reference, the levels for a value stock, are:
PG: P/E = 18.7, Price/Book = 2.57, Price/Sales = 1.95, and Price/Cash Flow = 13.10.
Value Stock: P/E < 15, Price/Book < 1.5, or at least not > 3.0, Price/Sales < 1.50, and Price/Cash Flow < 10.00
The stock has a beta of .4, implying it is less than half as volatile as the general market. The technicals indicate the reality that the stock has been in decline since April, with the charts presenting a somewhat grim picture, at least for traders who happened to be long at the start of the recent decline. All of the commonly-referenced technical indicators known as oscillators indicate the stock is oversold. None of these readings are surprising for a stock that has dropped 10% over the most recent two months. The take-away from the technicals is that the stock has recently declined, and now would be an excellent time to buy, IF the stock represents long-term value.
Ratings and Sentiment
As is typical for a well known large cap stock, analyst coverage is extensive. S&P rates the firm as only a Three-Star, i.e. a Hold, but with Low risk, and with an Earnings and Dividend Quality rating of A+, the highest available for that category. Morningstar rates it a Four-Star stock. Thomson-Reuters indicates that there are twenty analysts following the firm, with five rating PG a Strong Buy, five a Buy, nine a Hold, and one Under Perform. Various other ratings of interest are: Schwab - D, Under Perform, Credit Suisse - Out Perform, Reuters - Out Perform, Argus - Buy, The Street - Buy, Ford Equity - Hold, Columbine Capital - Hold, Thomas White - Hold, and EVA Dimensions - Under Weight. The ratings seem to be weighted slightly towards the positive, with a few dissenters.
I always do a search on Seeking Alpha as part of my stock research on a firm, to see if any articles are available which might offer further insights. As I anticipated, there are many articles available on PG. There are, in fact, too many to list, but I will flag one that I thought was of particular interest and somewhat unique: "Procter & Gamble: History Of A Dividend Champion," by contributor David Van Knapp. He presents some very interesting facts regarding the company history of PG, which for me helped to put the current issues in perspective.
Before I conclude, in the interest of full disclosure, I want to note that I am not a financial professional, nor am I certified in any way as a financial advisor. I am an independent, individual investor, focusing on dividend-paying stocks exclusively.
As anyone reading this far has probably guessed, I believe the present weakness in PG shares presents an opportunity to acquire shares at a better price than is usually available for this mega-cap blue-chip firm. I already had what I consider to be a "full" position in the stock, per my position sizing rules, having acquired the shares in multiple purchases in the April to September 2010 time-frame. My average cost is $60.60 per share. For a top quality holding, I will allow myself to go over my preferred maximum size, if an opportunity arises, such as we have today with PG. Accordingly, I acquired additional shares during the present weakness at a price of $60.25, on 6/20/2012. I would have to be able to buy more at $58 or less to be tempted further, which for a time looked like might be a possibility, but the stock has since recovered a bit, dampening my "animal spirits" for the moment. If sometime over the next couple of years PG rises into the 70s, I will likely sell my "excess" shares at that point, while still maintaining my "core" holding in the stock. That sums up how I view the current PG situation and my action plan for taking advantage of the opportunity it has presented.
Disclosure: I am long PG.
Additional disclosure: I am a subscriber to Investment Quality Trends and the Morningstar Dividend Investor. Other than that, I have no relationships with either of these publications.