Procter & Gamble: A Flicker of Hope Shines Through

Procter & Gamble (NYSE: PG  ) has for a long time been one of the most outstanding stocks in the consumer defensive sector. The company has an excellent track record of creating long-term shareholder value, and a sound dividend-paying track record. But the Cincinnati company, famous worldwide for products such as Duracell, Crest, Pampers, Tide, and Pantene -- to name but a few of its well-known megabrands that bring in over $1 billion each year -- has lately been struggling with uninspiring revenue and earnings growth.

P&G's anemic 0.58% revenue growth over the last five years places it among the largest companies with the lowest top-line growth in the S&P 500. But apparently, P&G is not alone; its poor growth is a sign of general industrywide malaise. Its industry peers Unilever, Clorox, and Kimberly-Clark have all been deep in the doldrums, although P&G seems to be hardest hit.

What's ailing P&G?
Procter & Gamble is one of the biggest and most respected global consumer brands. But this does not make it immune from macroeconomic pressures, such as the struggles many consumer goods companies have been facing in emerging markets.

P&G skews toward higher-priced goods, and this has been affecting its sales. Ever since the financial crisis of 2008, consumers worldwide have tightened their purse strings. Widespread bargain hunting, even in developed economies such as the U.S., has also become the norm.

P&G has a history of innovation. But its pipeline of new and innovative products has remained quite dry lately. These trends have been collectively slowing down sales for the company.

A mini-turnaround?
Procter & Gamble is, however, finally sputtering back to life after a series of serious restructuring efforts. In the third quarter of fiscal 2014, P&G reported 3% organic revenue growth. While that's nothing to write home about, it's nonetheless a big improvement over its sub-1% growth over the last couple of years. The company's EPS grew 5%, aided by intense cost-cutting measures -- the company expects to trim about $10 billion of its expenses by 2016.

P&G has managed to reduce its workforce by about 14,000 employees since 2009 to about 121,000 currently. Its revenue per employee has also improved 21% since 2010 to the current $681,500.

P&G's profit margin had taken a huge plunge from a high of 17% in 2009 to a low of 11.5% in 2012, spurred by the aftereffects of the 2008 financial meltdown. This had a huge effect on the company's profitability.

In fiscal 2012, however, the company's fortunes started improving. P&G recorded a 5% rise in net profit to $11.3 billion in fiscal 2013, but revenue growth clocked in at just 1%. In the most recent quarter of the current fiscal year, the trend of weak revenue growth continued as the company reported flat revenue of $20.6 billion.

Although Procter & Gamble still has some ground to cover before its profit margin returns to pre-2008 levels, indications are that its profit margin and operating income have started to stabilize.

Healthy cash flow and dividend growth
Procter & Gamble's reduced profitability also took a hit on its cash flow. In the last quarter, however, its cash flow improved to $3.16 billion. Although that level is still below its peak cash flow of $4.2 billion, achieved back in March 2010, it is, nevertheless, a good 12% improvement over the previous year. The company's cash and short-term reserves also jumped from $5.9 billion in the previous year's comparable quarter to $10 billion.

P&G is a distinguished Dividend Aristocrat with a record of paying dividends consistently for more than 100 years, and growing dividends for 58 consecutive years. Ironically, the company's penchant for growing dividends is also one of the reasons its cash flow has been under some pressure lately. P&G paid out $6.5 billion in dividends last year. Its payout ratio has also grown from under 40% five years ago to 60% currently. This suggests the company's dividends might not grow that much going forward. The shares currently yield 3.2%.

P&G shares sport a forward P/E ratio of 19.1, which looks quite expensive. But the valuation is in line with the consumer discretionary sector average of 18.9.

Procter & Gamble recently sold its underperforming pet foods division to giant candy maker Mars, Inc. for $2.9 billion in cash. This is good for investors not only because the cash will go to fatten its cash reserves, but because the no-stock deal will also ensure the company's shares are not diluted.

The decision to sell its pet foods segment seems like a good idea since the industry seems to be in shambles. Leading pet food company PetSmart (NASDAQ: PETM  )  recorded a 0.6% drop in same-store sales and another 2.2% fall in comparable transactions in the most recent quarter. This was the first time the company's comparable-store sales have fallen since 2000. The company also cut its earlier full-year earnings guidance from $4.42-$4.54 to $4.29-$4.39.

The pet food business is, however, a high-margin business, and PetSmart's profit margin sits around 30%. The company remains solidly profitable even after the lowered guidance. PetSmart fears that same-store sales could fall again in the current quarter. But for the full year, the company expects same-store sales to remain flat, while its top line grows in the low single digits.

PetSmart, however, has its fair share of attractive qualities. One of these is its strong track record of share buybacks.

The company has also been growing its dividend nicely since 2009. Although the current yield of 1.4% looks minuscule for dividend investors, the company's payout ratio is still very low, which leaves it with plenty of room to grow its dividend in the future.

The current sales slump by PetSmart is more likely than not a temporary blip the company will outgrow. It might therefore be a good idea to buy shares now, since they are down about 23% year to date.

Conclusion
Procter & Gamble is showing signs of recovery after its five-year slump. The company's cost-cutting and austerity measures instituted four years ago seem to be bearing fruit. Although the shares look quite expensive, they are still a good investment, especially for income investors.

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10/21/2014 3:49 PM
PG $84.56 Up +0.38 +0.45%
Procter & Gamble CAPS Rating: ****
PETM $68.94 Up +1.31 +1.94%
PetSmart CAPS Rating: *****

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