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The ability of Procter & Gamble (NYSE:PG ) to consistently grow sales at a rate exceeding inflation is one of the pillars of shareholder returns. The company returns tremendous amounts of cash with an expected total return of US$18Bn in 2022. This performance has led to a share price which leaves little upside.
Referencing the dividend yield against T-bills, and applying a margin, a minimum yield of 3.25% seems sensible before initiating or expanding a position. This desired dividend yield implies the stock should be bought at a level of US$112. This target presents a 22% discount against the current price but is not out of reach considering a looming recession. Although this company’s stock is great to own, the current macro-economic outlook suggests patience will be rewarded before a position is initiated.
Procter & Gamble is a consumer goods company which was founded in 1837. The success of the company is supported by a portfolio of famous brands such as Old Spice, Oral-B, Tide, Pampers and many more. As a result, dividends have been paid for the last 132 years with dividend increases over the last 66 consecutive years.
The organizational structure of the company mainly consists of five Sector Business Units, which are shown in figure 1. Across the board the contribution of each segment to net earnings is in line with distribution of net sales. This indicates performance of the business units is aligned and there is no massive underperformance in any of these. Furthermore, the company mainly derives sales from developed economies as North America and Europa make up for nearly 70% of net sales.
Figure 1 – Fiscal year 2021 sales by segment and region (pg.com)
One of the reasons PG has been able to consistently raise the dividend are the strong brands and consequently its pricing power. To demonstrate this organic sales growth has been plotted against US inflation in figure 2.
Figure 2 - Organic sales growth versus US inflation (pg.com, bls.gov; chart by author)
Over the last decade, the company has been able to align sales growth with inflation. Admittedly the sales growth was mediocre from 2008 to 2018 when compared to the years prior. On the other hand, the company again showed increased performance from 2018 onward, the reason will be explained later on.
More important however is the ability of the company to ramp up sales growth when inflation started to rise in 2021, see the blue dots in figure 2. The moment the FED retired the designation ‘transitory’ PG took action. This was also highlighted by the company during the Q3 results presentation, see figure 3. For readers less familiar with this company, the PG fiscal year runs from July till June. This means Q3 FY ’22 covers the months January till March of 2022.
Figure 3 - Organic sales growth Q3 FY22 (pg.com)
Another testimony to the strength of this company is the fact Q3 growth was not merely driven by price increases, but volume was raised as well. In spite of high inflation, PG doesn’t solely rely on pricing to boost the bottom line, but is also able to achieve volume growth.
Just looking at the annual performance in figure 2 the ability of this company to track inflation on a quarterly basis is not immediately clear. However, the blue dots in this figure and the data in figure 3 clearly show the agility of this conglomerate.
The first three quarters of fiscal year ’22 organic sales growth averaged nearly 7%. Given the recent trend in sales growth versus inflation, it may be expected Q4 organic sales growth will be a double-digit number as well. This will result in an annual organic growth rate of more than 7%, in line with the guidance given by the company.
Before diving into the dividend growth, it should be mentioned the dividend stated in the annual reports is lower than one would expect multiplying the quarterly dividend by four. E.g. in 2021 the company raised the quarterly dividend from US$ 0.7907 to 0.8698 cents per share. The FY21 annual report states a total dividend per share of US$3.24 as three quarters recorded the US$0.79 payment and only one quarter the raised payment of US$0.87 cents, summing up to US$3.24 in total. Comparing the dividend payments in the annual report, a gain of 7% is recorded when the 2021 dividend is compared to the year prior (2020: 3.03).
This presentation doesn’t do just to the dividend raises of the company. For example, the 10% increase in 2021, from US$0.79 to US$0.87, is not properly reflected by the ‘mere’ 7% gain based on the dividend per share from the annual reports. In figure 4, the growth of the quarterly dividend has therefore been used to show the dividend growth.
Figure 4 - Dividend growth, inflation and stock price (pg.com, bls.gov, yahoo finance; chart by author)
The dividend growth in this figure has been referenced against US inflation. The company recorded impressive dividend growth before 2009 after which the growth declined until 2017. Whereas dividend growth used to outpace inflation, in 2017 this wasn’t the case anymore.
In spite of an 8-year downtrend in dividend growth the stock price appreciated over the same time frame although there are clear episodes where the stock traded sideways. From a distance it doesn’t seem that bad, but examining the data more closely the stock traded sideways from 2010 to 2013 and again from 2013 to 2018. It was exactly this time period that dividend growth slowed as well.
The story shows similarity to the current situation of Unilever (UL), and not coincidentally founder and CEO of Trian Fund Management Nelson Peltz recently assumed a position in the board of UL. It seems history repeats itself as Mr. Peltz made exactly the same move at PG in 2018, his tenure is depicted in figure 4 by the yellow shaded area. As demonstrated in figure 2 sales growth got a boost in 2018, after Peltz got involved, and the same holds for the dividend per share which started to outpace inflation again as shown in the top part of figure 4.
Procter & Gamble does not only return cash to shareholders in the form of dividends. Over the last years the company upped its share buybacks and the amount of money spent on buybacks is actually exceeding the dividend payments. In 2021 for example, US$8Bn was spend on dividend, but an impressive US$11Bn was spend on buybacks.
The company is returning a tremendous amount of cash to its shareholders, and as demonstrated in figures 4 and 5, the combination of dividends and buybacks have fueled the share price over the last years. Nevertheless, as a recession is looming investors need to account for the possibility total shareholder returns will be reduced.
Figure 5 - Stock price versus share buybacks (pg.com, yahoo finance; chart by author)
Given the Dividend Aristocrat status the company will continue to focus on growing the dividend, which it’s perfectly capable of as demonstrated in the previous sections.
Yet, in its latest guidance the company mentioned increased organic sales growth, yet maintained EPS growth, indicating increased sales are not converted into additional earnings. The main reason is a US$3.2Bn headwind relating to commodity, freight and FX costs.
As the dividend will not be reduced, share buybacks form the variable component in the returns. Current guidance indicates share buybacks in the order of US$10Bn which is a reduction compared to last year (2021: US$11Bn). With recession fears growing and a reduction in share repurchases, a reverse of the stock’s uptrend is not far-fetched.
Procter & Gamble is a shareholder-oriented cash machine. The thing is that more investors have noticed this and the valuation in relation to the Consumer Staples sector is hefty, see figure 6.
Figure 6 - SA factor grades (June 2022) (seekingalpha.com)
The factor grades rate a company relative to a sector on a number of metrics. From the figure it’s clear that PG is valued at a premium against competitors while growing less fast. For example, the Price/Sales ratio (both TTM and FWD) show a difference of more than 200% compared to the Sector Median. The difference with the sector concerning the P/E ratio is more than 20%.
Comparing PG against peers instead of an entire sector, it follows the stock is valued in line with companies such as Colgate-Palmolive (CL) and Kimberly-Clark (KMB). Obviously, these are also two household names with strong track records and appealing dividend policies leading to valuations with little upside.
The recent selloffs have been indicative of what may happen when recession fears dominate trading. The surprise hike by the Swiss national bank was sufficient to tank markets. That said, the VIX has been relatively low meaning we have not seen a real fire sale. In a recent article I've argued a VIX of 37 is a panic threshold where money is to be made (or lost for that matter), but we haven't seen these levels yet. It appears investors are not yet ready to throw the towel in the ring.
Actually, investors have been rotating from growth into value, which should benefit a company like PG. The share price however disagrees and has trended lower over the last two months from a high of US$163 to the current level of US$144, in between going as low as US$131. For this reason, I believe the stock will drop further when recession forecasts remain persistent. After all, the rotation has been underway for over 6 months, but the stock price decline of PG is more recent and aligns with the growing fears of a recession.
So, with a quality value play like PG potentially continuing the downtrend it becomes important to assess at which level one would invest. The company has demonstrated dividend growth can keep up with or outpace inflation. The current valuation however leads to a 2.76% dividend yield which is not massive especially in times of high inflation. With bond yields and interest rates on the rise, TINA is about to retire meaning the dividend yield is increasingly less attractive as the same yield can be made with T-bills.
Referencing the dividend yield against Treasuries, and applying a margin, a minimum dividend yield of 3.25% is what I require. With annual dividend payments of US$3.65 per share, this translates into a share price of US$112. Admittedly this target is substantially lower than the current price, but, with a potential recession on the horizon, not out of reach.
For this article data has been used from, amongst others, PG’s Q3 FY22 Earnings release. In the current environment risks are plentiful and as such the potential headwinds management presented in the Q3 earnings release are shown in figure 7.
Figure 7 - Potential headwinds (pg.com)
Especially the last point is valid as the largest economy in Europe, Germany, is under an ‘economic attack’ with gas supplies being choked. As the EU operates as some sort of a union, this is not merely the problem of Germany. Next to that, if one of the strongest economies of Europe slides into a recession, the entire bloc will follow. With 22% of net sales coming from Europe, PG will not escape unscathed. This is not yet accounting for PG’s home market North America where the outlook is less dire, but not rosy either.
PG’s ability to consistently grow sales at a rate exceeding inflation is one of the pillars of shareholder returns. The company returns tremendous amounts of cash to its shareholders with 2021 returns totaling US$19Bn in dividend and buybacks.
Given the Dividend Aristocrat status the company will continue to focus on growing the dividend and share buybacks form the variable component of the returns. Current guidance indicates share buybacks in the order of US$10Bn which is a reduction compared to last year (2021: US$11Bn). Do note this still implies US$18Bn of cash is spent on dividends and buybacks in fiscal year 2022. This performance results in a share price which leaves little upside.
In spite of a rotation from growth to value stocks, PG’s stock price trended lower in the last two months led by growing fears of a recession. Current geopolitical events indicate Europe will slide into a recession and with 22% of net sales coming from Europe, PG will not escape unscathed.
This company is great to own and for those who have the stock in their portfolio the suggestion is made to hold the position and let management return cash. Yet, for those looking to add this company to their portfolio (yours truly), the current macro-economic outlook suggests patience will be rewarded before a position is initiated. Referencing the dividend yield against T-bills, and applying a margin, a minimum dividend yield of 3.25% seems sensible. This required yield translates into a share price of US$112. With the stock trading around US$144 at the time of writing this may seem out of reach, but in my years of investing I’ve learned patience is often the most valuable asset.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.