Procter & Gamble: A Blue-Chip Dividend Stock, Too Expensive

Stock Market


Proctor and Gamble offices, Cincinnati, Ohio

sharrocks / iStock Unreleased via Getty Images

Introduction

In a previous article, I analyzed Unilever (UL) and found the company not too attractive. I analyzed Unilever as I lack exposure to the consumer staples sector, which is my largest sector in the dividend growth portfolio. While Unilever is not attractive enough, I am still looking at other candidates in the sector. I consider both new positions as well as additions to existing ones.

The consumer staples sector is very diversified and contains different industries with dozens of household names from Philip Morris (PM) to Coca-Cola (KO) and PepsiCo (PEP). In this article, I will look at one of Unilever’s competitors in the personal care industry- Procter & Gamble (PG), a well-known American blue-chip company.

I will analyze the company using the graph below, which represents my methodology for analyzing dividend growth stocks. I am using the same methodology to make it easier for me to compare analyzed stocks. I will look into the company’s fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it’s a good investment.

Methodology Khen

Khen Elazar

According to Seeking Alpha’s company overview, The Procter & Gamble Company provides branded consumer packaged goods to consumers in North and Latin America, Europe, the Asia Pacific, Greater China, India, the Middle East, and Africa. It operates in five segments: Beauty, Grooming, Health Care, Fabric & Home Care, and Baby, Feminine & Family Care.

Procter & Gamble logo.svg

Wikipedia

Fundamentals

The company managed to grow sales steadily yet slowly in the last five years. Sales are up 20%, and this is mostly due to organic growth. In the last quarter, organic sales were up 6%, which is a significant increase compared to the two previous quarters with 4% organic growth. Going forward, according to the consensus of analysts as seen on Seeking Alpha, investors should expect mid-single digits revenues growth rate.

Chart
Data by YCharts

The company is converting the sales into EPS, and more importantly for dividend growth investors into free cash flow. The company’s FCF per share has more than doubled over the last five years due to sales growth, margin expansion, and limited share buybacks. Going forward, according to the consensus of analysts as seen on Seeking Alpha, investors should expect mid to high single digits EPS growth rate, which will be translated to FCF growth. For 2022, the company’s current guidance implies a 6-9% growth.

Chart
Data by YCharts

Procter & Gamble has been paying an increasing dividend for 65 years. The next dividend in May will be the 67th dividend increase in a row. This dividend king is paying a safe 2.2% dividend with the payout standing at 59%. The current dividend is safe, yet with the current payout ratio, investors should expect the next increases to be in line with the company’s EPS and FCF growth. Thus, investors should expect increases of around 6% annually.

Chart
Data by YCharts

In addition to dividends, Procter & Gamble is also returning capital to shareholders in the form of buybacks. The company’s buyback plans are not extremely aggressive, and the company decreased the number of shares outstanding by a little over 6% in the last five years. As the share price is close to its all-time high, it makes a lot of sense for discretionary use of buybacks, as their effectiveness is limited.

Chart
Data by YCharts

Valuation

The company has seen its valuation skyrocketing over the last twelve months. The forward P / E ratio has increased from 22 last year to 27 at the moment when taking into account the 2022 estimates. Paying 27 times earnings for a consumer staples company that grows steadily, but not at an extremely high pace is risky. I believe that at the moment, Procter & Gamble is trading for a risky valuation.

Chart
Data by YCharts

The graph below from Fastgraphs.com amplifies how expensive Procter & Gamble has become. You can easily see how the share price is detached from the average valuation blue line. The company’s average P / E is 20, and the current P / E is 27. The company is forecast to grow at a somewhat higher pace, 6-9% compared to 6.6% on average, but in my opinion, it is not enough to justify such a premium over the average valuation.

fastgraphs analysis

Fastgraphs.com

To conclude, Procter & Gamble is the bluest blue-chip company. The company is a dividend king, with a steady growth of sales, earnings per share, free cash flow, and thus dividends. The company is also returning cash in the form of dividends. However, the company’s fundamentals are not growing at a pace fast enough to justify the current valuation that resembles a big tech.

Opportunities

The short-term opportunity for investors is the current short-term trend of shifting from growth to value. We see investors divesting capital from growth stocks into value stocks. Procter & Gamble as a blue-chip and a dividend king is a haven for investors who wish to stay in equity as there is no other viable option but prefer safer equity. The current premium is due to the consistency you gain from Procter & Gamble.

Procter & Gamble is highly diversified. The company is selling its products worldwide. The Procter & Gamble brands are sold in the United States and other developed markets, and also in emerging markets. In addition, the company has a vast offering that includes dozens of brands in different sub-sectors. This diversification allows the company to be less vulnerable to weakness in one market, or harsher competition with a single brand.

Procter & Gamble may outperform when the market is volatile. The low beta and high consistency is an advantage when volatility is higher. The company is a consumer staples company that focuses on items that are used daily by people around the world. Consumption of these products is not affected by geopolitical tensions or any political changes in Washington. Therefore, companies like Procter & Gamble tend to outperform when the business environment is challenging. In 2008, shares have declined “only” 32% compared to the market 50% + decline.

Risks

The first risk here is the margin of safety. The company’s current valuation is simply too rich, and there is a significant risk here. If the company does reach its 2024 EPS estimates of $ 6.94, but the valuation will return to its average valuation of 20 times earnings, the company’s share price will be $ 138.8. Therefore, investors might be underwater after dividends with the current valuation, even if the company performs well.

The second is the competition. The company is selling basic staples, and while it manages to push its brands and market them as mostly premium brands the competition is harsh. Procter & Gamble is competing with other premium brands such as those offered by Unilever on the quality. It also competes with private labels on price. So far the company managed to compete well, yet it is still a challenge.

The competition will be more challenging due to the inflationary environment. At the moment inflation stands at 7.5%, and Procter & Gamble will have to raise prices and still compete. As the company is spending money on marketing, its cost structure is more challenging than the cost structure of generic brands and private labels. Therefore, in the short term, as inflation persists, competition will be harsher.

Conclusions

Procter & Gamble is still the best of the best. With a long history of dividend growth spanning over 65 years, the company is a blue-chip haven. Growth across the board fuels dividend growth including an incoming increase in May 2022. The company has several growth opportunities and risks that it can handle from a business perspective.

However, while Procter & Gamble is a fantastic company, it is far from being a fantastic investment. Even the best companies should only be bought for the correct prices. We now see the correction in growth stocks, promising names with fast growth are down 60% +. Procter & Gamble is expensive at the moment with a P / E ratio of 27, and investors who buy shares at the moment are taking a significant risk. I believe current holders should keep holding and wait for better opportunities to add.



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