Procter & Gamble (PG 1.52%) is the third-largest consumer staples stock by market capitalization behind Walmart and Nestle. The company will celebrate its 186th anniversary this year. It has raised its dividend every year for 66 consecutive years. It is a stable and reliable business that has long outlasted recessions because demand for its products remains steady no matter the market cycle. P&G is, in many ways, the most reliable dividend stock on the market when it comes to delivering a passive income stream.
Procter & Gamble continues to raise its dividend and buy back a ton of its own stock, which directly benefits shareholders by boosting earnings per share. But a few red flags have been popping up as of late. Let's go through some causes for concern to see if they are grounds for selling the stock despite its impressive track record.
Image source: Getty Images.
1. Slowing growth
Between fiscal 2015 and fiscal 2017, P&G underwent a restructuring that drastically reduced the number of brands in its product portfolio. The restructuring took a sledgehammer to the company's revenue but improved its operating margin and boosted profitability.
PG Revenue (TTM) data by YCharts.
Now, the issue is that P&G is struggling to grow profits at a rate that can support future dividend raises and buybacks. In the above chart, we can see that P&G's revenue is finally back around its pre-restructuring level. But its net income has flatlined compared to pre-pandemic levels. And in fact, net income is lower now than in fiscal 2016, during the initial benefits of the restructuring.
In the last 10 years, P&G has grown its dividend by more than 50%. The company paid a staggering $8.8 billion in dividends to its shareholders in fiscal 2022 -- which is great in the short term. But that kind of outlay could become an issue over the long term if those dividends aren't being supported by growth in the business.
P&G's operating margin sits nicely above its pre-restructuring levels, but it is now at a three-year low. In fact, if we look at the last four years to include pre-pandemic numbers, P&G's revenue is up less than 20%, its net income is up less than 30%, but the stock price is up 56.5%. This leads us to our next concern: valuation.
2. Expensive valuation
It would be one thing if P&G's slowing growth was temporary. But the company's short-term outlook is far from good.
As if the last few years weren't bad enough, P&G is guiding for flat to down 1% sales growth and EPS growth of flat to up 4% in fiscal 2023. That gives P&G a forward P/E ratio of 24.1 -- which is higher than the forward P/E ratios of Apple and Alphabet and much higher than the forward P/E ratio of equally solid Dividend King Johnson & Johnson, which is just 16.2.
P&G's track record for returning value to shareholders normally garners a premium valuation. But not at any price. And certainly not when the company's bottom-line growth rate is so low and its margins are declining.
3. Rising debt
Since P&G's dividend and share repurchase growth rate has outpaced its earnings and FCF growth rate, it has been relying more on debt. Today, the company's balance sheet is in its worst shape in 10 years. Total net long-term debt is now above its pre-restructuring levels.
PG Net Total Long-Term Debt (Quarterly) data by YCharts.
If we look at the most recent quarter, Q2 of fiscal 2023, we can see that the situation is only getting worse. P&G earned $3.93 billion in net income and $2.87 billion in FCF but distributed $4.23 billion to shareholders through $2 billion in buybacks and $2.23 billion in dividend payments. So its buyback and dividend expenses continue to outpace its earnings and FCF -- which is unsustainable.
The simple solution is to reduce the rate of buybacks and use FCF to pay down debt and get P&G's balance sheet in order. But given the company's low growth rate, short-term investors might prefer that buybacks continue because they boost earnings per share (EPS) by reducing the outstanding share count. Buybacks are a good thing when they are funded with FCF. But P&G's buybacks are coming at the expense of its financial health.
So long-term investors would probably prefer that the company reel in its buybacks, even if that means lower EPS.
P&G stock could be worth selling
P&G has long been one of my favorite dividend stocks and my personal favorite Dividend King. (Dividend Kings are S&P 500 companies that have paid and raised their dividends for at least 50 consecutive years.) But the company's fundamentals have deteriorated to the point that I think it is time to sell the stock.
The valuation does not make sense. The company's strategy depends on FCF and earnings growth -- which isn't there. P&G raised prices by 10% between Q2 fiscal 2022 and Q2 fiscal 2023, but it probably can't do that again this year. And without those price hikes, it would have posted 5% organic sales growth in fiscal 2022.
For P&G stock to be a buy, the company needs to prove it can grow organically without just relying on price hikes. Or the stock would have to trade at a reasonable discount to the S&P 500's P/E ratio of 20.9. If P&G had a P/E ratio of 17 (around that Johnson & Johnson level) -- which seems reasonable given its low to zero growth but strong track record -- the stock price would be $100.81. That's a lot less than the $142 per share or so P&G trades at today.
I can't wait for the day when the investment thesis for P&G makes sense again. But until the fundamentals improve or the stock price falls, there are too many better dividend stocks on sale now.
