For decades, Procter & Gamble (PG -0.71%) has created enormous wealth for its investors. But in recent years, the consumer goods titan has failed to keep pace with the overall market as its growth has decelerated. Is P&G doomed to underperform going forward? Or could it be poised for a rebound to its market-beating ways?
Let's take a look at the key aspects of P&G's business that are most likely to determine the answers to these questions.
1. Portfolio transformation
Since embarking on a major brand overhaul in 2014, Procter & Gamble has shed more than 100 underperforming brands to better focus on the 65 with the best growth and profitability prospects. P&G believes its new streamlined portfolio will make it a "faster-growing, more profitable, and far simpler company."
2. Getting leaner
As dramatic as its brand transformation has been, Procter & Gamble's organizational changes have entailed far more than just shedding brand assets. P&G completely redesigned its manufacturing and supply chain systems, slashed its overhead costs, simplified its organizational structure, and instituted a more focused advertising campaign for its best brands. Taken together, these moves have helped to drastically improve P&G's profitability.
3. Margin expansion
As part of its restructuring program, P&G cut more than $10 billion from its cost structure over the past five years, and it plans to achieve an additional $10 billion in cost savings over the next half-decade. These cost cuts have helped P&G's "core" (a non-GAAP measure that adjusts for restructuring and other non-recurring charges) gross and operating margins improve by several percentage points since 2012. In turn, P&G has delivered significant increases in core earnings per share even as its sales growth has remained sluggish.
4. Cash production
Another area where Procter & Gamble continues to excel is in its ability to generate sweet beautiful cash. The company's long-term target is to deliver annual adjusted free cash flow productivity (cash flow as a percentage of earnings) of at least 90%. P&G has crushed this goal over the last two years, and its adjusted free cash flow exceeded $12 billion in fiscal 2016, up about 20% from 2014. P&G's rising cash production has gone hand in hand with its cost-cutting initiatives, and investors should expect more of the same in the coming years.
5. Capital returns
As Procter & Gamble continues to gush cash, management remains committed to passing a large portion of these profits on to investors. In fact, the company plans to return a whopping $22 billion to shareholders in fiscal 2017 and up to $70 billion total from fiscal 2016 to 2019.
6. Dividend growth
Perhaps the most important aspect of Procter & Gamble's capital return program is its steadily growing dividend. Impressively, P&G has paid a dividend for 127 consecutive years, including 61 straight years of annual increases.
Over the last decade, dividends have accounted for more than half of P&G's total returns to shareholders. Yet with its dividend growth now slowing -- P&G's annual increases averaged only 2.3% over the last three years -- investors may need to adjust their expectations, as lower dividend growth could lead to lower overall returns going forward.
7. International opportunities
One area where Procter & Gamble does still have significant room for growth is in developing economies. Nearly half of its sales are generated in North America -- a well-developed market in which growth is likely to be modest from this point forward. Therefore, much of P&G's future sales growth will need to come from emerging markets in Asia, Africa, and Latin America. So, investors should monitor P&G's sales and market share figures in these regions closely, as these metrics will likely have a major impact on Procter & Gamble's stock price performance in the years ahead.
All told, Procter & Gamble remains a highly profitable business and a reliable cash generator. Yet achieving the type of sales growth needed to produce market-beating returns may prove challenging, and P&G will likely need to find a way to win in high-potential international markets if it's to do so. Still, investors seeking a steady, high-yield, and relatively low-risk stock could do far worse than Procter & Gamble.