By How Much Will Procter & Gamble Raise Its Dividend?

| About: The Procter (PG)
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Summary

PG is expected to announce its next dividend hike in early April.

The company has paid a dividend for 126 consecutive years and has grown its dividend for 60 years in a row.

However, it has been facing increasing challenges during the last few years, with no visible catalyst in sight.

Procter & Gamble (NYSE:PG) has paid a dividend for 126 consecutive years and has grown its dividend for 60 years in a row. Therefore, it is only natural that its shareholders are looking forward to the next dividend hike, which is expected to be announced in early April. The big question is the size of the raise that the shareholders should be expecting.

While this dividend aristocrat has historically offered exceptional returns to its shareholders, it has been facing increasing challenges during the last decade. To be sure, the company is experiencing declining sales for a 5th year in a row while it has essentially failed to grow its earnings per share during the last 9 years.

The main reason for the relatively poor performance in the last few years is the continuously heating competition in the retail sector, which exerts downward pressure on the margins. In addition, downward pressure is enhanced by private-label products and the expansion of dollar stores. While Procter & Gamble used to have strong pricing power thanks to its unique brand strength, its pricing power has gradually evaporated in recent years. Consequently, the stalwart has failed to grow for years, partly due to the exhaustive variety of products included in its portfolio, which make it harder for the management to maintain its focus and tackle these issues efficiently. That's why the stalwart has been divesting some brands lately while it has also been going through a major restructuring program. Nevertheless, the company still has a long way to go until it returns to its past growth trajectory.

As if these challenges were not enough, the stalwart is also facing a strong currency headwind due to the strong dollar. More specifically, the strong dollar is expected to reduce the earnings of the current fiscal year by more than $0.5 B while it has cost more than $4 B to the company during the last 4 years. Although the management tends to exclude the currency headwind from the core results, the dividend hike will certainly be affected by this headwind, as the latter significantly affects the cash flows in dollars. Moreover, as the Fed seems determined to significantly raise interest rates, dollar is likely to remain strong for the foreseeable future. Therefore, based on the current conditions, the management of Procter & Gamble is likely to be conservative in the upcoming dividend hike.

As the company has kept raising its dividend without simultaneously growing its earnings, the dividend payout ratio has markedly increased over years, as shown in the chart below. More specifically, while the payout ratio used to hover around 50% a decade ago, it has now approached the 80% level. Given the need for increasing marketing expenses and additional investments to restore growth, the company cannot keep growing its dividend at its glorious past rates. That's why it raised its dividend by only 1% last year, by far the lowest raise in its history.

The management also recently emphasized that it expected borrowing costs to significantly rise in the near future due to the upcoming hikes of interest rates. Therefore, the management is not likely to add a lot of debt to support a strong raise in the dividend. It is also worth noting that the management maintained a remarkably cautious tone in the recent conference call. It also kept mentioning the effect of "geopolitical challenges" as an excuse for its cautious guidance, even though the effect of the latter on the business performance is probably negligible thanks to the consumer-staple nature of the products.

Some shareholders may have become overly optimistic for the imminent dividend hike thanks to the recent rally of the stock. More specifically, the stock has rallied 4% during the last 10 days, as Trian revealed that it acquired a $3.5 B stake in the company and the market now expects Nelson Peltz to interfere with the management. However, the shareholders should realize that the recent rally is merely based on abstract expectations and has nothing to do with the business performance of the company and hence its imminent dividend hike.

To conclude, while Procter & Gamble has raised its dividend at an average 9% annual rate during the last decade, it has drastically reduced the growth rate during the last two years. To be sure, it boosted its dividend by only 3% in 2015 and 1% last year. Moreover, given all the above mentioned issues and the lack of any catalyst ahead, I expect the management to prove conservative once again when it announces the next dividend hike in April. Therefore, I expect the company to raise its dividend by 1% once again, from $0.669 to $0.676.

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.