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Procter & Gamble's Problems

Summary

A 1% dividend increase disappointed some investors - and with good reason.

But beyond simple yield issues, the increase itself shows how stretched P&G is at the moment.

Valuation still looks high here; much of the bull case rests on the impact of the current brand pruning, but I'm not sure how much value that really creates.

I still think fair value is below $80 - at least.

There's a long-running adage in politics and business that bad news should be delivered on Friday afternoon. Procter & Gamble (NYSE:PG) seemed to heed that advice last week, announcing a disappointing 1% increase in its dividend after the close.

Based on a review of PG's dividend history, the release was the announcement was the second made on a Friday in recent memory; the first was the 3% raise given last year. From my perspective, the raise indeed is bad news. The payout itself is of less interest to me than it might be to more yield-focused investors (though there's an argument the lower payout might reduce support for an interest in the stock from that class) than what the increase shows: P&G is a stretched company right now. That applies both to its capital allocation and its valuation.

The Dividend

source: author from PG dividend history

It's not just that PG's dividend increases are slowing, as seen in the chart above. It's the rate at which they are slowing. A company that regularly offered double-digit hikes (the 20-year average between 1992 and 2011, for instance, was 11.2%) has seen 7% increases (2012-2014) turn into 3% and now 1% increases. For any shareholder focused on DGI (dividend growth investing), this alone would seem to be an issue.

And it's not likely to be a temporary problem, either:

source: author from PG filings and press releases

There's not a lot of room here to increase shareholder returns; PG already is borrowing to fund share repurchases, and its targeted $7.5-$8 billion in buybacks this year are coming in large part due to the divestiture of Duracell to Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B).

Indeed, P&G highlighted the payout ratio problem in the dividend announcement issue, and it seems likely that the meager increase was offered simply to keep its now 60-year streak of dividend increases intact. But the choice to make such a low increase is an interesting one, particularly given that P&G still is expending a reasonable amount of cash on share repurchases: $2 billion in Q2 alone, for instance.

P&G said cash used in transactions - including $1.8 billion in cash sent to Berkshire in February - was part of the reason for the minimal dividend increase. But this is more a capital allocation choice: P&G is prioritizing share buybacks over the dividends. An increase to $0.70 quarterly - a 5.6%...


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