Friday, June 22, 2012

Has Procter & Gamble Turned into a Utility?



 source:  FactSet

Earlier this week, Procter & Gamble announced some bad news.

Despite an aggressive expansion plan that started a few years ago, P&G's sales and earnings are running below earlier expectations. Management told its investors and the Wall Street community to lower its revenue and earnings forecasts for the coming year.

The stock took a hit on the news, dropping almost 4% in one day, and is now trading at roughly the same level that it had been five years ago. Analyst reaction has been mixed - many had already anticipated the weak results, while others are calling for more drastic actions to take place. 

For years, P&G had been a "one decision" stock.  Management was highly regarded, and business schools paid close attention to the disciplined approach that P&G brought to bear on its widely diversified consumer product portfolio.

For the 10 year period ending in June 2002, P&G stock returned +250%, or more than +50% than the broader market averages.  Not surprising, P&G was among the most widely held stocks in institutional as well as individual portfolios.

The last decade has been different, however.  P&G has struggled to maintain its earlier growth rates. Although its stock price has kept up with the broader market averages, P&G's stock has lagged many of its competitors, and some are wondering whether the company has simply become too big to be anything more than a market performer.

But still:  Where there is skepticism there is opportunity.

I don't know whether P&G will ever return to its former self.  However, for investors starving for yield in this era of financial repression, the stock might not be a bad place to hide.

Let's start with the dividend yield.  P&G sports a 3.8% dividend yield which is almost certainly safe. The company has one of the strongest balance sheets in Corporate America (AA rated by the rating agencies) and its businesses are not particularly capital-intensive.

By comparison, utility stocks have been a favorite among investors looking for yield. As a group, utilities pay a dividend yield of 3.9% (I am using the utility exchange-traded fund - ticker XLU - for comparison).

The valuation of P&G and XLU are nearly identical:  15x trailing 12 months earnings. No one is particularly excited about the growth prospects for either, so valuation is also a draw.

But here's where I think that P&G comes out more favorably than utilities:  The relative valuation of utility stocks versus the S&P is at its historic high.  The group trades at a +20% premium to the market which seems to be to be pretty aggressive given the nature of the utility business.

P&G, on the other hand, is trading below its historic valuation versus the broader market over the past 10 years.  True, it traded lower - in 2009 - but for the most part investors were historically willing to pay a higher premium for P&G's combination of high dividends and consistent (albeit slowing) business results.

The chart I have posted above suggests that if we are truly in a low market growth environment - which seems likely - that high dividend, low expectation stocks like P&G are worth a look.