Value Investing

Dividend Aristocrats Part 28: Procter & Gamble Co (PG)

Dividend Aristocrats Part 28: Procter & Gamble Co (PG) by Ben Reynolds, Sure Dividend

Procter & Gamble (PG) was founded in 1837.  The company’s success over the last 178 years is nothing short of phenomenal:

  • Sales over $70 billion a year
  • Products in 180+ countries
  • 59 consecutive years of dividend increases
  • 21 brands with sales over $1 billion per year

Not bad for a company that sells disposable consumer goods products.  In fact, Procter & Gamble is one of only 17 Dividend Kings – dividend stocks with 50+ years of consecutive increases.

Procter & Gamble is the 3rd largest consumer goods company in the world, behind only Apple (AAPL) and Toyota Motors (TM).

Procter & Gamble has become a victim of its own success over the last decade…

Take a look at the company’s difference in earnings-per-share growth in the two periods below (fiscal years, not calendar years):

  • 1999 through 2008: Earnings-per-share growth of 10.3% a year
  • 2009 through 2015: Earnings-per-share growth of 2.0% a year

The company lost its focus on its core brands.  Procter & Gamble expanded its brand portfolio too aggressively.  The result was an inefficient organization that was not effectively allocating capital.

The company flourished under CEO A.G. Lafley who ran the company from 2000 through 2009.  Procter & Gamble struggled under his replacement, Bob McDonald.  Lafley came back to run Procter & Gamble again in mid-2013 at the request of activist hedge fund manager Bill Ackman.

Since Lafley’s return, Procter & Gamble has shed non-core brands and pledged to significantly reduce its work force.

But Lafley is not planning to stick around…

In June of 2015, Procter & Gamble announced it would be changing CEOs again.  Lafley is stepping down, and long-time Procter & Gamble employee David Taylor is taking over.

The quick change of CEO creates instability at Procter & Gamble.  Few expected Lafley to give up leadership after just 2 short years as Procter & Gamble’s CEO.  Taylor has been integral to the company’s renewed focus on core brands, and will likely continue Lafley’s strategy.  Taylor’s career with Procter & Gamble is shown in the image below:

Procter & Gamble

Source:  Procter & Gamble 2015 Shareholder Meeting Presentation, slide 34

Before discussing the continued cost-cutting and restructuring of Procter & Gamble, a quick overview of the company’s 10 ‘core’ brand categories

Procter & Gamble’s 10 Core Brand Categories

Procter & Gamble has 10 core brand categories which the company is focusing on:

  1. Oral Care: Key brands are Crest and Oral-B
  2. Baby Care: Key brands are Pampers and Loves
  3. Family Care: Key brands are Bounty and Charmin
  4. Feminine Care: Key brands are Always and Tampax
  5. Grooming: Key brands are Gillette, Venus, and Braun
  6. Fabric Care: Key brands are Tide, Ariel, Gain, and Downy
  7. Personal Health Care: Key brands are Metamucil and Nyquil
  8. Skin & Personal Care: Key brands are Olay, SK-II, and Old Spice
  9. Home Care: Key brands are Dawn, Febreeze, Swiffer, and Cascade
  10. Hair Care: Key brands are Pantene, Head & Shoulders, Herbal Essence, and Rejoice

Procter & Gamble

Source:  Procter & Gamble 2015 Shareholder Meeting Presentation, slide 19

Procter & Gamble is a global business.  With that said, the company is focusing on two key markets to drive profits:  China and the United States.

Competitive Advantage

When I last analyzed Procter & Gamble I wrote that “Procter & Gamble’s is its strong brand portfolio of disposable consumer products”.

That is just as true 50 years ago as it was last year.  It is still true today.  Procter & Gamble’s real value comes from its portfolio of high quality brands.

The company’s longevity comes from its intelligent focus on ‘low tech’ disposable products; things like deodorant, shampoo, razor blades, toilet paper, feminine products, and paper towels.  These are things people will always need.

Procter & Gamble supports its (now more focused) portfolio of brands with large advertising spending.  The company spends between $8 billion and $9 billion a year on advertising.  This amount of advertising buys tremendous product awareness that smaller competitors cannot match.

The massive size of Procter & Gamble helps it to outspend its rivals.  The company can pressure suppliers into lower prices and more favorable financing terms.  Inexplicably, Procter & Gamble has only recently taken advantage of pressuring suppliers into longer payback periods:

  • 2013 accounts payable of $0.2 billion
  • 2014 accounts payable of $1.1 billion
  • 2015 accounts payable of $2.3 billion

Procter & Gamble has an average long-term interest rate of 3.4%.  The company’s additional ~$2 billion in accounts payable is saving the company around $70 million a year in interest payments.

Cost-Cutting and Restructuring

Procter & Gamble is going to great lengths to focus on its core brands.

The company is either done or nearly done with its brand divestiture program.  Procter & Gamble’s most recent large divestitures were Duracell to Berkshire Hathaway, and a portfolio of 43 beauty brands to Coty.

The company is shedding employees as a result of its brand reductions and efficiency focus.  Non-manufacturing headcount is down 23% since highs in 2011.  The company plans to reduce headcount a further 2 to 7 percentage points.

Manufacturing employee count is down 19% since 2012 highs.  Procter & Gamble plans to further reduce manufacturing employee count by another 6 to 11 percentage points.

In addition, the company is restructuring its United States supply chain.  The image below shows the before-and-after of this restructuring:

Procter & Gamble

Source:  Procter & Gamble Morgan Stanley Global Consumer Conference, slide 18

Procter & Gamble’s Expected Total Return

Procter & Gamble is targeting 7% to 9% long-term earnings-per-share growth.  The company saw constant-currency earnings-per-share grow 12% in its most recent quarter.

The company is suffering from currency effects due to the strong dollar.  Eventually, the dollar will stabilize versus other global currencies and Procter & Gamble will return to growth.

The question is, can Procter & Gamble really achieve earnings-per-share growth of 7% to 9% a year going forward?

I believe the company can.  Here’s how:

  • Sales growth of 3% to 4% per year
  • Share repurchases of around 2% per year
  • Margin improvements of 2% to 3% per year

Procter & Gamble should be able to continue expanding margins as it reaps the benefits of its significant restructuring process.

The company returns nearly 100% of its earnings to shareholders through dividends and share repurchases.  I expect this trend to continue.  Share repurchases of around 2% of shares outstanding a year are likely (if a bit conservative).

Revenue growth of 3% to 4% will come from a mix of better-focused advertising and continued innovation within the company’s ‘core brands’.  It is possible that Procter & Gamble continues to struggle with revenue growth.  A downside scenario would see the company growing revenue around 0% to 2% per year.  I believe it is more likely the company grows revenue in the 3% to 4% a year range thanks to its high quality brand portfolio.

In addition to Procter & Gamble’s expected earnings-per-share growth of 7% to 9% a year, the company’s stock currently pays a 3.5% dividend.  This gives investors in Procter & Gamble expected total returns of 10.5% to 12.5% a year going forward at current prices.

Recession Performance

Procter & Gamble is an extremely stable corporation due to its diverse portfolio if disposable consumer goods.

As one would expect from a highly stable business, Procter & Gamble operated well throughout the Great Recession of 2007 to 2009.

The company saw a 1.65% decline in EPS from 2008 to 2009, and a 1.40% decline from 2009 to 2010.  Procter & Gamble’s growth stalled through the recession, but the company remained profitable throughout and saw only modest downturns in earnings-per-share.

Procter & Gamble’s earnings-per-share each year through the Great Recession of 2007 to 2009 and the subsequent recovery is shown below:

  • 2007 earnings-per-share of $3.04 (high at the time)
  • 2008 earnings-per-share of $3.64 (high at the time)
  • 2009 earnings-per-share of $3.58 (modest decline from high)
  • 2010 earnings-per-share of $3.53 (recession low)
  • 2011 earnings-per-share of $3.93 (new high)

Valuation & Final Thoughts

Procter & Gamble is currently trading for an adjusted price-to-earnings ratio of 19.1.  This is likely around fair value for a high quality business such as Procter & Gamble.

One of the more appealing aspects of Procter & Gamble is its stability.  The company’s stock has a low price standard deviation of just 17.5% – one of the lowest of any publicly traded stock.

Procter & Gamble’s mix of quality brands, low volatility, reasonable growth prospects, fair valuation, and high dividend yield give it a high rank using The 8 Rules of Dividend Investing.