Bob McDonald’s Quandary: Save the World or Maintain P&G’s Dividend, Yielding 3.5%
Procter & Gamble’s (PG) CEO Bob McDonald took the helm in July 2009 and quickly articulated a strategy that sounds as much Gates Foundation as it does Tide-and-Crest: “to touch and improve lives, now and for generations to come.”
One imagines McDonald, who has an unlined face not unlike spiritual author Eckhart Tolle, sitting cross-legged and quietly mulling how P&G products and people can save the planet.
It’s thus jarring to read up on the actual doings at the House of Bob, P&G’s Cincinnati headquarters. Events suggest a very un-Zen-like life for McDonald, constantly shuffling P&G’s businesses and tweaking its financial structure. One now envisions him down in the engine room, pulling all the levers. Poor Bob, and poor P&G shareholders.
If there’s a “higher purpose” in all this, it seems to be the storied P&G dividend. More on that in a moment.
Back to Bob McDonald’s frantic life: P&G is finally about to close its sale of Pringles to Kellogg (K) – way behind schedule. It’s initial deal with Diamond Foods (DMND) dragged on and on before falling apart due to the nut company’s accounting problems. Nice recovery with Kellogg but then word leaked out last week that P&G plans to move its skin, cosmetics and personal care business from Cincinnati to Singapore, dealing a blow to the headquarters city.
Other puzzling moves in the House of Bob: After divesting its giant pharmaceutical business in 2009, P&G announced plans for a new joint venture with Teva Pharmaceuticals (TEVA) last year. (This was the same Teva P&G had beat in a 5-year patent battle over an osteoporosis drug it subsequently offloaded as part of its pharma divestiture.) Separately, P&G unveiled a restructuring plan last year and then unveiled an even more grandiose “productivity and cash savings plan” in February. If P&G were running for election, it would surely be accused of flip-flopping.
The share price under McDonald shows a 22% gain, but he was lucky to step in when P&G shares were near their economic-collapse nadir. Generally it’s been a slide sideways under McDonald.
A slide sideways would actually have been welcome news on the profit front:
But what the heck – we’re all here for the dividend, right? P&G is a long-time member of S&P’s list of dividend aristocrats, companies that have increased their payout annually for at least 25 years. Its announcement of a 7% quarterly dividend increase last month makes FY2012 (ends June 30) the 56th consecutive year that P&G has raised the quarterly rate and the 122nd year in a row that the company has paid dividends. In fact, P&G has not missed a dividend since its incorporation in1890.
But the dividend is one very expensive habit. Price tag: $6 billion this year. And it’s one that can tie a CEO’s hands as he grapples with all the challenges facing P&G. Especially when the payout ratio creeps above 60% of net income as P&G’s has done since the start of the year. That’s utility territory, Bob.
The company keeps careful eye on free cash flow – which it defines as operating cash flow minus capital expenditures, “an important measure because it is one factor in determining the amount of cash available for dividends and discretionary investments.” It states very clearly in financial statements that: “our first discretionary use of cash is dividend payments.” So much for saving the world.
That’s all well and good as long as things go the way they’re supposed to. Last year, they didn’t. P&G’s free cash flow fell 24% to $9.9 billion. The problem? Not capital spending per se, which at $3.3 billion was not much more than $3.1 billion the year earlier. But in the prior year, P&G could offset that capital spending with a gain of $3 billion on the sale of its pharmaceutical business. Last year, the big gain it was likely to realize on the sale of Pringles never materialized. Free cash flow took the hit.
The year’s dividend obligation totaled $5.8 billion for the fiscal year that ended June 30 and would’ve been larger had the company not reduced the number of shares outstanding through a $7 billion share repurchase program financed by issuing a combination of long and short-term debt. By fiscal year-end, P&G’s total debt had increased to $32 billion from $29.8 billion the prior year -- to fund general corporate purposes, including stock buyback programs, according to the 10-K.
This year, P&G has avoided a repeat. Yes, the dividend obligation rose yet again (to $4.5 billion through the end of the third quarter). But this year, the company has trimmed to $4 billion the amount spent on stock repurchases. A $1.3 billion net increase in debt plus proceeds from exercising stock options have together boosted free cash flow so that the company is once again meeting its cash flow targets. And it has yet to benefit from the expected gain from the Pringles sale.
But all this really begs the question . . . how does this benefit P&G’s business – Crest and Gillette and Olay and Tide? Slow growth is the curse of the consumer products industry. Running your company to support the dividend won’t likely fix that. When does the dividend become the tail that wags the dog?
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