Procter & Gamble: Grab It For The 3% Dividend, Stay For The Transformative Benefits

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About: The Procter & Gamble Company (PG), Includes: BRK.A, COTY
by: Willow Street Investments
Summary

The company is long past providing significant share price appreciation to its investors, but investors should consider its shares for its dividend and its transformative action benefits.

Potential investors should purchase the company’s shares at a price that allows it to collect an initial dividend yield of about 3.25 percent then reinvest such dividends.

The company’s latest earnings comforted investors somewhat, but investors remain in a “show me” mode in regard to PG’s revenue/earnings growth prospects.

With major divestitures behind it, the company has reduced its brands dramatically, realigned its compensation strategy and continues to reinvest restructuring cost savings to drive growth.

While investors may pressure the company to break up again, we believe the company has too many levers to pull to reignite more consistent revenue/earnings growth.

Procter & Gamble (NYSE:PG), a global consumer product innovator and marketing powerhouse, is long past its time of rewarding investors with outsized share price appreciation. Still, most investors should still consider it as part of the more conservative portion of their portfolio for its above-average dividend and nominal share price appreciation likely to result from its recent transformative activities. If an investor has the opportunity to purchase the company's shares with an initial dividend yield of about 3.25 percent to 3.5 percent and harvest annual dividend increases of even the smallest amount they will be well on their way to a relatively decent long-term return with a less volatile stock. In other words, if a stock such as PG offers a 3.25 percent dividend return and offers long term share price appreciation averaging 4 percent a year, then a PG investor can obtain a long-term return of about 7 percent. The level of return that PG offers, therefore, is satisfactory when it is part of an overall portfolio that mixes value-oriented stocks along with growth stocks and everything in between.

The appeal of PG shares as a part of any portfolio is that such shares are relatively "safe" in comparison to other stocks. While PG faces competition along many of its product lines from branded and private label products, the company supports its multiple billion-dollar iconic brands with its expertise of innovation, marketing and promotion to fend off and stand up to such competition. In addition, the company's research and development capabilities enable the company to launch new products and to extend product lines to adapt to changing consumer tastes.

With this in mind, even the casual stock market observer has heard in recent years that PG has struggled to attain revenue/earnings growth given its overall size and unruly breadth of its product offerings. To overcome its revenue/earnings growth struggles due in part to adverse currency effects and global economic weakness, the company is in the midst of a multi-year plan to streamline its business operations to focus only on its strongest and most profitable brands. The plan has included a strategy of focusing on its core brands that will create a faster-growing, more profitable PG that is simpler to operate. As such, PG has divested about 60 percent of its brands that were experiencing sales and profit decreases along with a lack of profitability.

As the company's divestiture strategy nears completion, it will focus on 65 core brands. The company's retained core brands are leaders in their industry category or segment, about 20 with sales of $1 billion to $10 billion, about 15 with sales of $0.5 billion to $1 billion and the remainder with strong brand equities in sales of $100 to 500 million. Such remaining core brands also account for about 90 percent of company sales and over 95 percent of the company's profit. As PG has carried out its divestiture strategy, the company also continued to decrease its expenses by streamlining management, reducing costs and eliminating jobs under a restructuring plan. PG continues to show progress from its transformative activities, but there are some critics who believe the company will remain unwieldy due to its massive size and should be broken up into multiple companies that are better able to focus on their core strengths. (We discussed the positives and negatives regarding a PG break up in an earlier article.)

The company's most recent quarterly report showed that they exceeded analyst revenue and earnings estimates. In particular, PG announced adjusted earnings of $1.03 per share, a 5 percent increase from the year-ago quarter due to improved operating margins and a larger contribution from non-operating items. Currency-neutral core earnings per share increased 12 percent due to higher volumes. The company reported net sales of $16.52 billion, flat with the year-ago quarter due in part to adverse currency effects. Organic revenues (excluding the impact of acquisitions, divestitures and foreign exchange) increased 3 percent due to an increase in organic shipment volumes.

Each of PG's five business divisions recorded positive organic sales growth as well. The company's gross margins increased 50 basis points to 51.6 percent due to productivity cost savings and higher volume benefits that were offset by adverse currency effects, an unfavorable product mix, innovation and capacity investments and increased commodity costs. The company continues to engage in an ongoing aggressive cost-cutting plan to decrease spending in cost centers such as its supply chain, research and development budget, marketing and overhead costs. PG maintained its organic sales growth projection at about 2 percent for fiscal 2017 while they also expect its core earnings per share to increase in the mid-single digits from its fiscal 2016 core earnings. The company's latest earnings report has comforted investors somewhat as its shares now trade in a less volatile narrower range, but such investors remain in a "show me" more in regard to PG's revenue/earnings growth prospects.

While PG's management continues to push forward its transformation, investors and analysts continue to grow impatient. As noted, investors may eventually reassert their push to have PG reconsider breaking itself up to make the growth-impaired company more nimble and create a more entrepreneurial corporate culture. Although PG has yet to follow the break-up route to date, it has engaged in divestitures by completing its sale of its Duracell business to Berkshire Hathaway (NYSE:BRK.A) and its sale of 43 perfume, hair-care, and cosmetics brands to Coty, Inc. (NYSE:COTY) for $12.5 billion. With such major divestitures behind it, PG has whittled its brands down to its goal of 65, down from 200. In response to analyst/investor pressures, the company has also realigned its compensation strategy to tie it more directly tied to performance and increased accountability.

Despite these transformative moves, there is investor sentiment that PG may be underestimating its competition and lacking innovation. In the next year or so, if PG is unable to reestablish consistent revenue/earnings growth, the analyst/investor push to break up the company is likely to reappear. While we recognize the adversities that PG faces, we also recognize that the company is a peerless global consumer innovator, manufacturer and marketer of convenient, effective and value-added products that consumers want and trust. As our regular readers may know, we always say we never bet against American food companies' ability to adjust and adapt to food consumption trends. Well, we hold the same belief for American consumer product powerhouses such as PG. A company such as PG has too many levers to pull to right its ship and return itself onto a course for more consistent revenue/earnings growth. The only question then for a potential PG investor then is at what price should they consider picking up PG's shares for a long-term hold and we refer them to our price range noted below for our suggested buying range. Although we believe that PG may break up into two or three pieces in the intermediate term, in the near term PG's strategy remains focusing and growing its core power brands, cost restructuring and innovation creating new products.

Our View

We believe that all investors should consider owning PG's shares for its dividend and the likely benefits from its transformative actions. In particular, potential investors should preferably strive to purchase the company's shares at a price that allow it to collect an initial dividend yield ranging from 3.25 percent to 3.50 percent and then reinvest such dividends until PG's transformative actions and restructuring efforts reveal more consistent results. As noted above, the company is concluding its transformation towards its best-selling and most profitable core brands with an overall goal of driving more consistent revenue/earnings growth over the long term. In the near-term, however, such efforts to divest brands and reshape the company's product portfolio have adversely affected the company's sales and profits. As also noted above, PG is engaged in an ongoing operational cost reduction program whereby such cost proceeds are being reinvested in product innovation and advertising to drive revenue growth. While such efforts adversely affect revenue growth in the near term, they set the stage for improved revenue and earnings growth over the longer term.

The current price-to-earnings ratio for PG is about 22.55, and the shares yield 3.15 percent. The company's forward price-to-earnings ratio is about 21.90, based on fiscal year 2017 earnings estimates of $3.86 and about 20.25 based on fiscal year 2018 earnings estimates of $4.17. We should note that estimates for each year have fallen slightly over the past three months. We believe investors with a long-term horizon should purchase PG shares in a price range of $73.00 to 77.15 (on a price-to-earnings ratio range of 17.5 to 18.5 based on fiscal 2018 earnings estimates) during the next overall market sell-off and reinvest the dividend until the company's transformation begins to show positive results or until the company announces a break up. Over the long term, PG, an expert innovative product developer, marketer and seller of multiple iconic billion-dollar brands, will succeed with its strategy of divestiture of its lesser brands to reward shareholders for years to come with share price appreciation, improved dividend increases and share repurchases.

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Disclosure: I am/we are long PG. 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.