Procter & Gamble: Dividend King; 2.56% Yield Now Not Expensive

by The Compound Investor

Procter & Gamble (PG) – in business since 1837, paying dividends since 1890, listed on the NYSE since 1891, increasing dividends since the late 1950s. Some folks call dividend investing faddish, but I love Steady Eddies like this one. Pandemics, wars, recessions, booms, busts – Procter just racks up quarter after quarter of profits, dividends and retained earnings. That it achieves this by selling simple household products like Gillette, Olay and Tide is the icing on the cake. If you ever want or need some buy-and-hold inspiration, these types of stocks deliver it in spades.

Procter last featured here way back in late 2019. At the time, the shares changed hands for somewhere in the $120 area on the back of fiscal 2019 earnings of around $4.52 per share. Some quick math put the stock at 26.5x earnings, which seemed a bit rich for such a stodgy name. Obviously this was all pre-COVID, though the pandemic has not been bad for business here. Organic sales growth in the last four quarters has averaged circa 8%, comfortably higher than the mid-single-digit figures registered before COVID. With the share price largely unchanged since last coverage, the stock is now at a more reasonable valuation.

Quality Business

Like a lot of stocks here, the buy-and-hold case ultimately rests on earnings quality. Procter owns around 65 brands in total, which is less than it used to, but around 20 of these generate yearly sales in excess of $1b. Further, it operates across the household goods sector and owns leading brands in multiple product categories, which ultimately amounts to a very strong offering to retailers all over the world.

Procter buttresses this position in numerous ways. One, it can afford to spend $7.25b on advertising each year, supporting consumer demand for its products. Two, it can afford to spend a further $1.9b on R&D each year, bringing new and innovative products to market. Three, its size gives it a cost advantage, allowing it to produce goods at a lower cost than upstarts. Overall, this amounts to a position that is very hard to overcome. Signposting these advantages are high returns on invested capital, which typically land in the 40s region excluding goodwill.

Recent Results

As mentioned above, recent results have been very good here. Procter posted 8% organic sales growth in fiscal Q2 2021 – with that driven by 5% volume growth and low single-digits from price gains. The firm registered positive growth across all of its business segments.

(Source: Procter & Gamble CAGNY 2021 Presentation)

Home Care, the category which houses brands such as Fairy Liquid and Dawn, continues to be the standout performer. Home Care sales jumped 32% over the first half fiscal 2021 versus the equivalent period in fiscal 2020. Clearly there is a big positive COVID effect baked in there, though most parts of its business are growing nicely. Only Baby Care, which houses Pampers diapers, failed to put in positive year-over-year (“YOY”) growth. Even in that case organic sales growth remained flat at exactly 0%. So, nine categories posting positive organic sales growth in total, and one exactly flat – not a bad set of sales figures at all.

(Source: Procter & Gamble 2Q21 Results Presentation)

Turning to earnings, core earnings per share (“EPS”) increased 17% YOY to $3.27. The firm also updated full year guidance: organic sales growth is now seen coming in at circa 5-6%, with that leading to EPS growth in the 8-10% region. That implies 2021 core EPS in the $5.65 area. Oh, one other thing to like about Procter right now – leverage seems quite modest. Procter reported gross debt of around $31b against circa $12b in cash on the balance sheet. Net debt works out to around 1x annual EBITDA – fairly conservative versus peers. Note that annual retained earnings stand at circa $5.75b here – with that number based on circa $14b in net profit and around $8b in dividends.

Valuation

Procter shares ended last week at around $123.53 each. Quick math implies a current price-earnings (“PE”) ratio of around 22, clearly better than the 26.5 sported back in late 2019. The quarterly dividend currently stands at $0.7907 per share, equal to a current yield of 2.56%. The payout ratio stands somewhere in the 60% region.

It would be easy to shrug at the above numbers. I mean, a PE of 22 and a 2.56% dividend yield? Yeah, it doesn’t look like much. That said, low interest rates need to be taken into account, while Procter is also putting down decent growth numbers. Furthermore, its high quality business can also justifiably attract a premium valuation. That is because the firm can continue to spend large amounts of cash on dividends and buybacks without harming the growth prospects of its core business. Procter has spent around $135b shoveling cash into shareholders’ pockets over the past decade, and there is no reason why that can’t continue.

At 22x earnings, Procter arguably requires somewhere in the region of 3-4% annual sales growth to make things work. Operating leverage can then bump profit growth up to a slightly higher clip. After that, well, we have a current 2.56% dividend yield to lump on top. Spending a portion of its retained profit on things like acquisitions and stock buybacks can add a point or so to the mix too. All-in-all, that would provide for decent shareholder returns here.

Note

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