Procter & Gamble: Brexit Play

| About: The Procter (PG)

Summary

Procter & Gamble’s stock was at a 52-week high following a strong fiscal 3rd quarter and positive investor sentiment.

Procter & Gamble’s strong Balance Sheet and effective restructuring program will enable it to continue paying – and possibly raising – its dividend.

Brexit may provide investors with the much needed market pullback before taking a position.

Analysis

Solid Fiscal Third Quarter. Procter & Gamble (NYSE:PG) has had a strong showing of late. Even after experiencing a 7% decline in its fiscal 2016 third quarter revenues, the consumer goods giant reported adjusted earnings of 86-cents per share, an improvement of 29% over last year's third quarter earnings - and 4 cents better than the consensus estimate.

As a consequence of its robust performance and investors' positive outlook for the stock, Procter & Gamble is trading at a 52-week high - even so, it is still around 11% lower than the high end of analysts' $95 target for the stock, so it could have room to run further.

Dividend Impact & Outlook. Despite the surge in its stock price, Procter & Gamble currently has a dividend yield of 3.25%, which is among the highest in its sector - and better than the sector's average of 3%. Thus, an investor who buys $10,000 of Procter & Gamble stock can expect to receive around $320 a year in passive income - in addition to owning a stock that is generally acknowledged as a blue chip.

Considering Procter & Gamble's recent run-up and high dividend yield, should dividend-conscious investors still buy the stock? Let's consider the following:

First, Procter & Gamble's financial strength ratios are fairly robust. While its Working Capital ratio is at approximately 1.0 - which is considerably less than the average for its sector and somewhat surprising for a blue chip stock - its trailing year's quick ratio of 0.61 is well above the sector average of 0.37.

Meanwhile, Procter & Gamble's leverage ratio of 1.1-to-1 is below the 1.5-to-1 ratio for its sector. Dividend Investors should find its robust liquidity and low leverage reassuring - they imply that short-term operating cash requirements and debt-servicing obligations will not pose an impediment to dividend payments.

Second, Procter & Gamble's third quarter earnings improved due to a further deleveraging of its operations; cost cuts added around 3.2 percentage points to its operating margin. Consequently, Procter & Gamble's operating margin is now at 21%, which is well above the industry average of 5.9%. A higher operating margin means more cash with which to repurchase shares and pay dividends.

What's more, Procter & Gamble disclosed in its latest SEC filings that it generated $11.3 Billion in operating cash flow during the last quarter - a 6% improvement over the same period a year ago. This puts Procter & Gamble's current free cash flow yield at 5%, is consistent with its yield over the 18 months. It is also on-par with the 4.8% cash flow yield of a large competitor like Kimberly-Clark (NYSE:KMB). This is important because it means that Procter & Gamble has the capacity to continue raising its dividend, which it has done on a consistent basis since 2004.

Third, as part of its broader restructuring efforts, Procter & Gamble is expecting another $10 billion in savings over the next half-decade on top of savings that it has already made. While management has said that it intends to reinvest the majority of these savings in R&D, building its brand and improving its packaging and products, it's probable that some of these savings will also be passed on to shareholders in the form of stock buybacks and dividends.

Finally, Procter & Gamble's revenues are growing. To be sure, its headline revenue number contracted - but this was the consequence of foreign currency adjustments and product line divestments. On an organic basis, Procter & Gamble's revenues actually rose by 1% - hardly the strongest rate of growth but much better than its 0.38% annual growth rate in the last 5 years.

With management focusing on a smaller portfolio of 65 brands across 10 fast-growing business categories, Procter & Gamble is likely to see better growth rates going forward. In fact, analysts are currently anticipating that its revenues will grow by over 6% a year over the next 5 years - certainly not as sizable as the 13% growth rate forecasted for its sector, but considerably faster than its revenue performance over the last few years.

CONCLUSION

Considering all of the foregoing, investors would do well to add Procter & Gamble to their portfolio - on a market pullback. Buying the stock last week might have been sub-optimal given the uncertainty of the summer months and the fact that the stock was at a 52-week high. But with Brexit already causing the stock to lose almost 1.5%, investors are advised to watch it over the next week and start accumulating a position as it bottoms out. Since we're fairly certain the Procter & Gamble will maintain its current dividend, waiting for a further pullback would have the advantage of not only lowering an investors' cost of entry but also raising their effective dividend yield.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.

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