There isn't much about Procter & Gamble's (PG -0.92%) current business trajectory for investors to cheer. Sales growth slowed from its already weak pace last quarter, marking seven out of the last eight quarters in which organic revenue either held steady or fell.
The 3% to 4% expansion pace it used to enjoy looks out of reach for now.
Despite a few bright spots in the detergent and baby care segments, P&G predicts that overall organic growth will be in the neighborhood of just 1% for the fiscal year that ends this quarter, compared to gains of 4% for rival consumer goods giants Kimberly-Clark (KMB -1.28%) and Unilever (UL -1.02%).
Yet there are reasons to be optimistic, too. P&G has completed its portfolio transformation that's whittled its competitive categories down to just 65 brands from over 160. The resulting company should have 15% lower sales, but only 5% lower earnings. In other words, it will be more profitable, more focused, and better able to react to market shifts. If all goes according to management's plan, that approach will soon yield market-beating growth after years of underperformance.
At least one Wall Street pro agrees with that reading. An analyst at Jeffries just boosted P&G's stock to a "buy" rating while placing a $95 per share price target on shares (for double-digit growth from here). Echoing management's comments, the analyst cited a slimmer portfolio that should help the company return to near 4% organic growth by the end of the next fiscal year. That wouldn't be enough to beat the broader industry, but it will be a hefty improvement over the current pace.
Better early than never?
As attractive as that thesis sounds (buy a blue-chip stock right before its business fundamentally improves), a P&G investment carries some important risks. The two biggest I see revolve around valuation and execution.
On price, Procter & Gamble's stock isn't cheap at 23 times the past year's earnings compared to 21 times for both Kimberly-Clark and Unilever. Sure, profits are being artificially held back by foreign currency swings and brand divestments, pushing that PE ratio higher. Yet subdued earnings growth has a real impact on P&G's investors, most directly through weaker annual dividend raises.
The second point to watch out for is that while higher quality growth may be on the way, it isn't likely to show up in a dramatic, or even consistent fashion. Chief Financial Officer Jon Moeller warned investors about this in April, saying "improvements in top-line growth won't happen overnight, and they won't happen in a straight line." P&G's big challenge is on innovating within its key brands, which takes time.
If you believe in management's turnaround plan, then that volatility shouldn't matter. The business is likely to produce solid returns over the next five years under that scenario, and paying a slight premium over rivals won't kill your returns. On the other hand, buying P&G here in hopes of a quick rebound would be risky. The stock could spike to $95 per share on improving growth trends -- or it could just as easily keep underperforming a weak global market for consumer goods.
A high dividend yield and surging cash returns to shareholders help compensate for those business risks, but investors have to stick around long enough to let these financial benefits accrue. And they have to be willing to sit through substantial operating volatility in the meantime.