Procter & Gamble (NYSE:PG) is a classic dividend stock for the portfolio. However, investors might be cautious on fresh exposure to PG stock after a rally of 31.8% in the last year. I am of the opinion that valuations still remain at sane levels and PG stock is worth considering.
Talking about valuations, Procter & Gamble stock currently trades at a forward price earnings ratio of 24.1. An interesting comparison is the Vanguard Consumer Staples ETF (NYSEARCA:VDC), which is currently trading at a price earnings ratio of 24.3.
Further, the stock price has trended higher by 31.8% in one year and the Vanguard Consumer Staples ETF has moved higher by 12.3%. Clearly, PG stock has been an out-performer as compared to the broad consumer staples sector and valuations still remain comparable.
I also believe that as the probability of a global recession in the next 12-18 months increases, there will be a flow of funds into relatively defensive stocks like Procter & Gamble. The stock has a beta of 0.4 and sells products that are more of necessity than luxury.
The company’s CFO, Jon Moeller, does acknowledge that consumers can possibly shift to cheaper products during a recession. However, the company plans to counter that risk by focusing on “creating a superior product worth the investment.”
Therefore, valuation is not a concern and Procter & Gamble is likely to remain relatively insulated from an economic downturn.
Big Scope for Market Penetration
Procter & Gamble reported healthy organic sales growth for the first quarter of 2020. I believe that strong growth momentum is likely to sustain.
As of 2019, P&G derived 45% sales from North America and 23% sales from Europe. Sales contribution from Greater China was just 9%. Furthermore, India, Middle East & Africa contributed to just 7% of sales.
China and India are alone home to 2.5 billion people with rising standards of living. These two countries can be sustained growth drivers for Procter & Gamble.
It is worth noting that the company’s sales growth in China has remained robust even with macroeconomic headwinds. In addition, the proportion of premium product sales in China is higher as compared to the rest of the world.
As the sales contribution from China increases, I expect the operating margin to expand on premium product sales growth.
Even in India, the company’s sales growth has been in the “high double digits.” India is also in a phase of economic slowdown and as GDP growth accelerates, the company’s growth can gain further traction.
Overall, markets like China, India and Brazil, among others, will ensure steady growth in top-line and cash flows for Procter & Gamble.
Shareholder Value Creation Will Continue
For fiscal 2020, Procter & Gamble expects to pay $7.5 billion in dividends. In addition, the company plans to repurchase shares worth $6 to $8 billion.
For 1Q20, the company reported free cash flow of $3.3 billion and this implies an annualized FCF of $13 billion. This gives the company ample headroom to create value.
It is also worth noting that for 1Q20, the core operating profit margin was 24.3% as compared to 21.7% for 1Q19. Margin expansion, organic sales growth and growth in premium products would imply higher FCF in the coming years.
Therefore, I expect dividend growth to sustain and that will continue to attract investors. As a matter of fact, Procter & Gamble was able to increase dividends even during the financial crisis of 2007-09. The current slowdown is unlikely to impact steady dividend growth prospects.
Final Words on PG Stock
PG seems to be fairly valued but forward PE multiples can get attractive if organic sales growth sustains. Even after a sharp rally in the last year, investors can consider fresh exposure to PG stock.
China and India are likely to be top-line growth drivers with muted, but stable growth momentum from the United States and Europe.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.