John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
After going sideways for several years, Procter & Gamble Co.'s stock has finally broken out of its rut.
In the past 12 months, the consumer products giant's stock – which I own both personally and in my Strategy Lab model dividend portfolio – has surged 27.5 per cent, including dividends, beating the S&P 500's total return of 24.6 per cent over the same period. When you factor in the sinking of the loonie, the return for Canadian investors has been an even more impressive 30.7 per cent.
Whenever a stock runs up like that, it's natural for investors to think they've missed the boat. But I consider P&G a long-term holding and, if anything, I would be looking to add to my position on any price weakness.
For now, I'm quite happy to hold on to my P&G shares and collect the dividends. Here's why:
It's a dividend growth machine
P&G has raised its dividend for 57 consecutive years and it's not going to stop now. In the past 10 years alone, the dividend has more than doubled. What's more, the yield of 3 per cent is 50 per cent higher than the S&P 500's yield of 2 per cent, and P&G's payout ratio is a comfortable 54 per cent of earnings.
"Given Procter & Gamble's stable cash flow, we expect the dividend to continually increase over time," said Edward Jones analyst Jack Russo, who projects a five-year dividend growth rate of 7 per cent.
It's a brand powerhouse
P&G has more than 250 brands, including about 25 that generate sales of more than $1-billion each. These "megabrands" include Tide, Crest, Pampers, Duracell, Pantene and Iams, which enjoy broad consumer loyalty and trust and provide a solid platform for future growth and innovation.
The big money is on board
P&G's large investors include Warren Buffett's Berkshire Hathaway and Bill Ackman's Pershing Square Capital. The activist Mr. Ackman has said that P&G is "vastly under-earning relative to its earnings power" in part because of "bloated" overhead costs, subpar manufacturing productivity and an inefficient organizational structure.
He projects that P&G – which last year launched a $10-billion (U.S.) cost reduction plan – can boost organic revenue growth to 5 per cent from about 3 per cent currently and raise its EBIT (earnings before interest and taxes) margin to 24.4 per cent from 18 per cent. That would drive earnings per share to about $6 by 2016 from about $4 for the year ended June 30.
Applying a multiple of 20 times to that $6 a share would produce a stock price of $120. The stock closed Tuesday at $80.54.
The new (actually old) CEO is proven
Mr. Ackman has already achieved one of his goals: convincing the board to bring back respected CEO A.G. Lafley, who replaced outgoing CEO Robert McDonald on June 30. Mr. Lafley ran P&G from 2000 to 2009, during which time sales doubled, thanks in part to his bold acquisition of Gillette. The day his re-appointment was announced, P&G's stock jumped 4 per cent – illustrating the confidence investors have in his leadership.
Now that he's in the CEO's chair again, look for acquisitions, spinoffs, product innovations and other measures to reinvigorate the company. Mr. Lafley is expected to discuss his plans on Aug. 1, when the company releases fiscal fourth-quarter results.
Emerging markets are a huge growth avenue
P&G generates an estimated 40 to 45 per cent of sales from emerging markets, up from about 20 per cent in 2000. But that's still less than competitors such as Colgate-Palmolive and Unilever, both of which derive more than half their sales from developing countries. If P&G can use its size, marketing muscle and supply chain expertise to grab a bigger slice of the emerging markets pie, the stock will respond.
The valuation is reasonable
P&G's stock price isn't cheap, but it isn't expensive compared with its peers and it may have more upside if things unfold as Mr. Ackman hopes. According to Globeinvestor, P&G trades at about 18.5 times next year's estimated earnings, compared with 20.6 for Church & Dwight, 19.3 per cent for Colgate-Palmolive, 18.6 for Clorox and about 17.5 for Unilever.
"If P&G can deliver improvements as we expect, earnings should step up meaningfully in the coming years and shareholders should be rewarded," Odlum Brown analyst Stephen Boland said in a recent note.
Closing thoughts
There are risks with P&G, as with any company. It faces intense competition, not only from other brand-name consumer products makers but from grocers and drugstores that offer cheaper private-label alternatives. Convincing cash-strapped consumers, many of whom switched to private labels when the global economy headed south, to once again embrace branded products could be a challenge.
Also keep in mind that Mr. Ackman's record isn't perfect. His bet against Herbalife, for example, has not worked out the way he had hoped. Canadian investors also need to be aware of the added volatility produced by currency swings when investing in U.S. stocks such as P&G.
Those caveats aside, P&G possesses global scale, market-leading brands and strong record of innovation. Long-term investors will almost certainly be rewarded with growing revenues, earnings and dividends and a stock price that – while it remains unpredictable in the short term – should gradually rise over time.
John Heinzl