Monday, January 28, 2013

Is Procter and Garmble Now A Growth Stock?

One of my most popular posts last year was titled "Has Procter & Gamble Turned Into A Utility?"

Written on June 22, 2012, the piece noted that for the last 10 years P&G returns and price movements had closely matched the returns for the utility sector. But perhaps the overall negative outlook that the share price of P&G at the time reflected an opportunity.

Here's what I wrote (I added the emphasis today):

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 envir
onment - which seems likely - that high dividend, low expectation stocks like P&G are worth a look.

Last week P&G reported earnings last week that were ahead of Wall Street's expectations, and the stock jumped. 

Since  I wrote my piece last summer, the stock is up +22%.

The point of mentioning all of this is not necessarily to call attention to my good call last summer (well, not totally) but rather as a way of showing that even boring consumer staples stocks can be attractive when sentiment gets too negative.

So what about now?  Is P&G's run over?

Well, I must confess I am less excited about the stock than I was last summer. If nothing else the stock today is trading at 21x trailing 12-month earnings, so it can hardly be considered cheap.

But the skepticism about the company still remains.  Here's what the Financial Times wrote over the weekend:

That is why P&G's improved outlook is, ultimately, a disappointment.  The company expects 1-2 per cent sales growth (after losing a couple of percentage points to currency effects).  On the bottom line, earnings per share growth is targeted at 3-6 per cent.  Given that about 2 percentage points of that EPS growth will come from share buybacks, one can only wonder when the cost-cutting that management has often promised will lead to meaningful operating leverage. Maybe {an} index fund is the way to go, after all.