With P&G (NYSE: PG) having a forward yield of 3.1% versus 2% for the S&P 500 (NYSEARCA:SPY), many investors may conclude it is a top-notch income play. However, we think there is more to a company's dividend appeal than its headline yield, with dividend growth prospects being crucial in deciding whether or not to invest in a stock for its income potential.
With that in mind, here are three reasons why we think P&G's earnings and, therefore, dividends will rise moving forward, with those same catalysts set to have a positive impact on its share price, too.
As this week's Q4 update from P&G shows, the company is making excellent productivity gains. Its core operating margin increased by 300 basis points in Q4, and this was primarily driven by productivity savings in gross margin.
Looking ahead, we think there is scope for further improvements in this space, with P&G in the midst of the biggest overhaul of its supply chain in its history. It is gradually moving toward a position where it has fewer brands, product lines and categories, while consolidating its plants, suppliers and organizations. Allied to this is a focus by the company to make its organisational structure much simpler and to encourage the sharing of ideas across its segments by making its staff more accountable. In our view, this improved efficiency and productivity is set to have a positive impact on P&G's profitability and dividends, as well as acting as a positive catalyst on its share price moving forward.
Innovation and investment
P&G is not seeking to boost sales through a major and across-the-board investment in pricing, but rather, is investing in product innovation to justify higher margins. For example, it has developed products such as Gillette FlexBall and Oral-B Powerbrush, which are expected to build category and brand sales. And with P&G committed to increasing its advertising spend as well as investing to a greater extent in its salesforce to build profitable distribution and shelf assortment, we feel customer loyalty could improve and cause profitability, dividends and P&G's share price to rise moving forward.
Furthermore, P&G's investment in its brands could help the company to improve household penetration rates in developed markets such as the US, Europe and Japan. And with P&G improving its strategic position in developing markets such as China, where consumer discretionary spending is forecast to rise by 7% per annum between now and 2020, we think its investment now will boost profitability, dividends and its share price moving forward.
Of course, investment must be allocated efficiently, and P&G's restructuring will ensure that, in our view. It is in the process of making asset disposals, such as Duracell batteries, as it seeks to become increasingly streamlined, and in our view, this makes sense, since the 10 business categories which remain offer leading market positions, product differentiation and business models which have proven over a sustained period to offer growth and value.
Additionally, a more focused P&G should naturally become more efficient and more profitable, since the 10 categories which will form the new P&G have seen their operating margins growing at a faster rate than that of the wider company in recent years. As such, we believe the company's restructuring will positively catalyze its bottom line as well as shareholder payouts and the share price moving forward.
With 60% of P&G's net sales being generated outside of the US, many investors may be nervous about the effects of negative currency translation on the company's earnings. For example, in the Q4 release, P&G stated that it expects its fiscal 2016 sales to be hit by a negative 6-7% impact from foreign exchange, as a stronger dollar hurts its reported performance. And with the US dollar expected to strengthen against a basket of currencies over the next year, it would be unsurprising for this trend to continue over the near term and medium term.
However, we believe the threat of a strengthening dollar is priced into P&G's valuation, with its forward yield of 3.1% indicating that it offers good value for money compared to the S&P 500. And with P&G having positive catalysts such as the prospect of further productivity gains, the effects of a major restructuring and the impact of investment in product innovation, we think its earnings, dividend and share price will rapidly rise moving forward.
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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.