While it’s encouraging Procter & Gamble Co (NYSE:PG) seems to be on the road to a turnaround — nudged by the prospect of an activist taking a more commanding role — it’s simultaneously concerning that PG stock is valued like that turnaround has already taken place.
That’s the gentle way of saying while the erratic 8% gain we’ve seen in the PG stock price this year was rooted in understandable enthusiasm, the company isn’t doing all that well just yet. It’s likely we’ll see the stock move lower before it moves meaningfully higher again.
Procter & Gamble shares are essentially forcing all interested parties to respect the fact that a company’s stock isn’t always a perfect reflection of that company’s performance prospects. This proverbial purgatory requires everyone to tread lightly, regardless of their expectations.
The good news is the war of words between activist investor Nelson Peltz and P&G has ended (mostly) amicably. Though his fund, Trian, didn’t technically win its proxy battle for such a presence, realizing it’s better to work with Peltz than against him, the company is bringing him into the inner circle anyway. And to be fair, Peltz brings valuable insight — and honesty — to Procter & Gamble. His track record of steering (yet not dictating) turnarounds speaks for itself.
Yet, he can push buttons more forcefully when needed. He’s largely credited with prompting the recent (and much-needed) regime change at General Electric Company (NYSE:GE).
Peltz is also deepening his relationship with P&G at a point in time when its turnaround effort was gaining traction anyway.
It’s been difficult for current and would-be owners of PG stock to see, but that’s by design. Relatively new CEO David Taylor is more interested in orchestrating a turnaround the right way rather than the quick way. Still, there are glimmers of hope. Last quarter’s top line grew for the first time in several quarters, and earnings are starting to edge a little higher — even if just barely — as well.
The bullish trajectory is compelling. The bad news is it’s shallow; and trading at a forward-looking price-earnings (PE) ratio of 20.7 suggests the market has unrealistic expectations about just how quickly Peltz will be able to accelerate the P&G revival.
Said less politely, the market’s priced PG stock for a rate of progress that just isn’t in the cards.
Meanwhile, the company’s dividend poses a mostly-overlooked problem. As Vince Martin recently noted, “Dividend growth has stalled out: double-digit increases last decade have given way to an average hike of just 2.4% the last three years. And yet even that slower growth has led to an increase in the payout ratio. What the company calls ‘Core EPS’ has been stagnant for years: the figure was $3.95 in fiscal 2011 and $3.92 in fiscal 2017.”
While earnings are slowly getting better, in that P&G is dishing out roughly four-fifths of its regular per-share profits as dividends, there’s little room left for dividend growth and funding a turnaround effort.
It’s the timing more than anything else, however, that’s the crux of the problem at hand.
PG stock logged a decent (even if volatile) 2017, but the momentum has already slowed as traders increasingly realize that it may not be until late 2018 when the next leg of the turnaround effort takes hold. It may be after that before Procter & Gamble can truly afford to meaningfully raise its dividend. The stock isn’t apt to hold its ground while results “catch up” with the PG stock price, as investors just aren’t that patient. Indeed, the market is starting to change its bullish mind about the company.
Take a look at the weekly chart of Procter & Gamble shares. Though it’s still up since its early November low, for the first time since the 2015 rebound PG stock has logged a lower high after making a lower low. Momentum has been waning for some time, but PG is dropping clearer hints of a slowdown now.
Even without the lower high in place, though, the chart’s action from just the past two weeks suggests the rally is starting to roll over.
Again, the dilemma Procter & Gamble shares pose to would-be buyers right now isn’t anything usual. Speculation and hope always skew a stock a little higher or a little lower than its plausible value. That’s just the nature of the market.
What is unusual in this case, though, is how long the divergence between the price of PG stock and the plausible, foreseeable value of PG stock has lasted. This sets the stage for a pullback that could be bigger than most investors expect from this seemingly stable blue chip name.
A move back into the lower $80’s is a distinct possibility before results improve enough to justify higher highs again.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.