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2019-10-11 03:21:26

Procter & Gamble (PG) failed to grow its earnings for several years in a row and thus underperformed the market by a wide margin. However, after an unprecedented restructuring program, the company has eventually managed to return to growth mode. Thanks to this turnaround, the stock has rallied 70% in less than 18 months. While the consumer products giant seems to have entered a sustainable growth phase, its breathless rally has sent its dividend yield to a 10-year low level of 2.4%. Therefore, income-oriented investors should probably wait for a better entry point.

Business overview

Procter & Gamble failed to grow its revenues and its earnings for seven consecutive years, until last year. The poor performance primarily resulted from the increased price-consciousness of consumers and the rising market share of private label products. In addition, large retailers engaged in a price war and thus exerted great pressure on their suppliers for lower prices.

Procter & Gamble has gone through a major restructuring in recent years in order to become more efficient. It has divested almost two-thirds of its brands, in an effort to sell the low-growth, low-margin products and focus exclusively on its most promising brands; i.e., the ones with the widest margins and the strongest growth potential. This restructuring project has reduced the number of brands from 170 to 65.

Fortunately for the shareholders, the restructuring efforts have eventually begun to bear fruit. In its fiscal 2019, which ended on 6/30/19, Procter & Gamble grew its organic sales by 5%, more than its 2-3% initial forecast, and its core earnings per share by 7%. The company achieved organic growth in 9 of its 10 product categories and in all the regional divisions where it has a presence. After three years of essentially flat organic sales in the U.S., the consumer products giant achieved 4% organic growth in the domestic market in fiscal 2019. Moreover, it maintained its strong momentum in China, where it grew its organic sales by 10%.

Even better, Procter & Gamble grew its organic sales by 7% in the latest quarter and thus smashed the analysts’ consensus of 4%. It was the strongest quarter in organic sales growth in more than a decade and it is a strong indication that the positive business momentum is likely to remain in place for the foreseeable future. Indeed, management provided guidance for 3-4% sales growth and 4-9% earnings-per-share growth in the running fiscal year. It is admirable that Procter & Gamble has exceeded the analysts’ earnings-per-share estimates for 17 consecutive quarters.

Growth prospects

Now that Procter & Gamble has focused on its most promising brands, it seems to have entered a sustainable growth phase. Goldman Sachs (NYSE:GS) has upgraded the stock from “Neutral” to “Buy” and expects the company to post organic volume and profit dollar growth in 12 of the next 13 quarters.

Moreover, management is doing its best to enhance the operating efficiency of the company and thus it is reasonable to expect further margin expansion in the upcoming years. It is remarkable that Procter & Gamble has advanced to the third-highest position in core operating margin and the second-highest position in after-tax profit margin in its peer group.

Source: Investor Presentation

To cut a long story short, Procter & Gamble is likely to continue growing its earnings per share at a meaningful pace, thanks to strong sales growth and further margin expansion.

Dividend

Procter & Gamble has paid uninterrupted dividends for 129 consecutive years and has grown its dividend for 63 consecutive years. It is thus a dividend king, with the 5th-longest dividend growth streak in the stock universe.

Unfortunately, the company has raised its dividend by only 5% per year on average in the last decade and 4% per year in the last five years. However, the lackluster dividend hikes in recent years have resulted from the absence of meaningful earnings growth. Now that the consumer staples giant has returned to growth mode, it is likely to accelerate dividend growth in the upcoming years, particularly given the healthy payout ratio of 64%.

On the other hand, it is important to realize that the stock has rallied 70% in less than 18 months. This unusually steep rally has led the dividend yield of the stock to a 10-year low level of 2.4%.

Data by YCharts

As we have witnessed in other consumer staples stocks, such as PepsiCo (PEP) and McDonald’s (MCD), part of the rally has resulted from the recent interest rate cuts by the Fed and its dovish outlook, which have rendered the dividend yields of dividend aristocrats much more attractive than they were a few months ago. Nevertheless, the 10-year low dividend yield of Procter & Gamble signals that investors with a long-term horizon should probably wait for a better entry point.

Valuation

Thanks to its breathless rally, Procter & Gamble is currently trading at a trailing price-to-earnings ratio of 26.8. This is by far the highest earnings multiple of the stock in more than a decade. On the one hand, the positive business momentum of the company and its resilience to recessions, which results from the strength of its brands, justify a premium valuation of the stock. On the other hand, the richest valuation of the stock in more than a decade should warn investors that the stock is somewhat overvalued and certainly much less attractive now than it was a few months ago. While the positive stock price momentum is likely to remain in place in the short term, the stock will have significant downside whenever it faces an unexpected headwind, such as higher interest rates.

Final thoughts

Thanks to its sustained restructuring efforts, Procter & Gamble has eventually returned to growth mode. However, the enthusiasm of the market for the turnaround and lower interest rates have triggered a breathless rally, which has resulted in a 10-year low dividend yield of 2.4% and a 10-year high price-to-earnings ratio. Although the stock price momentum is likely to remain positive in the near future, investors with a long-term perspective should probably wait for a better entry point.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.


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