Is This Great Dividend Stock in Danger?
Adrian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Only behind Johnson & Johnson (NYSE: JNJ) and well above Unilever (NYSE: UL) in my performance chart, Procter & Gamble (NYSE: PG) is among the best performing stocks in its industry. The latest earnings call for its fourth quarter of fiscal 2013 just came out, and it's a good time to analyze the future growth and profitability prospects of Procter & Gamble.
While the firm has one of the strongest global brands ever created, it is struggling to keep a top line that grows faster than 1%-2% per year. As competition increases and customers become more price sensitive, is Procter & Gamble going to be able to keep its position as the leading global household and personal-care firm over the next few years?
Understanding P&G's problems
First of all, we need to acknowledge that the size P&G has achieved is enormous, and it is a well-known fact elephant firms struggle to at least keep growth rates constant. The upside is that P&G enjoys all the benefits that economies of scale can deliver. The downside is that the annual P&G's growth rate for the past five years has barely surpassed 1%. Cash flow coming from core operations achieved its highest level in 2010, and since then, it has decreased. In a nutshell, organic growth isn't happening.
Source: Procter & Gamble Co. Annual Reports
Among the worst performing businesses in terms of revenue growth, we find the Grooming and Beauty segments. In the latest earnings call, management mentioned hair care (Pantene) and skin care remain in decline. So far, it seems that the way the company is dealing with its growth issues is by spending more budget on brand promotion and marketing. And although this may stop sales from declining further in the long run, it may not be as sustainable in the long run as product innovation.
Finally, Procter & Gamble has also had a profitability issue for the past four years, due to competitive pricing.The good thing is that the latest figures, after CEO Lafley's return, are early signs of a recovery. P&G reported an annual profit of $11.3 billion, a 5% increase that managed to beat Street expectations. There's a $10 billion cost-saving plan on its way to reduce head count, which could help EPS grow even further. As for the short-run, Lafley has promised core earnings per share growth of 5% - 7% for this year.
Can this elephant dance again?
P&G needs more organic growth to avoid disappointing investors. The good news is that the come-back of CEO Lafley could become a positive catalyst for revenue. Lafley ran P&G for 10 years since 2000 and did a superb job, making key acquisitions (Gillete) and almost tripling EPS in his time as a CEO.
Also the fact that P&G is still able to deliver meaningful growth in emerging markets is an opportunity that needs to be further exploited. Latin America and Asia still represent a small proportion of total revenue.
As for the United States, fierce competition from Johnson & Johnson, Unilever and Kimberley-Clark make it more difficult to achieve growth. But having strong brands and an increasing budget dedicated to promotion can at least prevent a decline. With a $256 billion market cap and P/E ratio of 25, Johnson & Johnson's brand may have been damaged by several product recalls in the company's over-the-counter drugs business. Considering this industry still remains highly brand-sensitive, this is an opportunity for P&G to steal market share that I believe the new management is already using it.
Of course, the drug business also has plenty of upsides. First of all, it adds diversification to its business portfolio. The Pharmaceutical business and the Medical Devices and Diagnostics business combined already represents 79% of total revenues. Drugs like Zytiga and Incivo have become massive growth drivers; Zytiga alone saw its sales jump 70% year over year. And although the stock is trading near its 52-week high, some other drugs like diabetes drug Invokana or Hepatitis drug Simeprevir (which is expected to receive FDA approval in the fourth quarter of this fiscal year) could become a positive revenue catalysts for the next quarter, taking the stock price to even higher levels. P&G doesn't have this kind of exposure.
Coming back to emerging markets, if P&G wants to increase its market share, it will have to steal it from Unilever. In terms of total sales mix, Unilever is far more exposed to emerging markets than P&G and sells better in many key markets, like Brazil, where despite P&G undercutting its prices by more than 30% (Morningstar), it has continued to maintain more than 70% of the personal and home care category. This shows how strong Unilever's brand has become in emerging economies, where the company is an early mover; it has more than 50 years of experience in Brazil, China, Indonesia and India.
Unilever's success in emerging markets, where it has recorded double-digit growth in sales for the past 6 quarters (for comparison, in the past quarter, sales in developed markets slipped 1.6%) shows that the current focus P&G is taking may be late, but late is better than never. In the latest quarter of 2012, its organic sales from China grew by 9%, Russia by 18% and Brazil by 17%. This suggests that P&G is still far away from reaching the geographical mix Unilever enjoys, but progress is certainly being made on that direction.
A good reason for holding: Amazing dividend yield
P&G may be having trouble with organic growth, but the increasing dividend is definitely a reason to hold.
The dividend has more than doubled since 2005 ($0.28 per quarter) and it is crisis-proof (notice it increased during the 2007-2008 crisis). The current dividend of $0.6015 per quarter, higher than Unilever but lower than Johnson & Johnson, suggests an annual yield above 3% and gives safety to investors.
The bottom line
P&G is struggling with growth rates. But as the household product manufacturer with more billion-dollar brands than any other competitor, I believe that its core cash flow is safe. An amazing dividend and the return of superb CEO Lafley add more reasons to hold. Considering market pressure from Unilever in emerging markets, and the strength of Johnson & Johnson beauty products in North America, the road to growth is certainly long and challenging. But to say P&G is in danger is too pessimistic. We can agree with the fact that this is not a growth stock, yet this could be a great investment for those looking to add more safety to their portfolios.
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Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson, Procter & Gamble, and Unilever. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!