Procter & Gamble (PG) reported fiscal Q4 earnings this morning, and that coupled with guidance was nothing short of a mixed bag. The strength of the dollar continues to weigh on sales and earnings, which was generally the reason why we entered a near term bearish trade a few weeks ago. Here’s what CFO Jon Moeller had to say on CNBC this morning:
There’s no escaping the fact that foreign exchange has had a big impact on both our top and bottom lines,” Moeller acknowledged—noting a 9 percentage point negative impact on quarterly earnings and 14 points on revenue.
Here was our original trade, placed on
Trade: PG ($81.25) Buy July 31st weekly 81 put for 1.60
The stock is down 2.5% this morning and with only a day until expiration we’re going to close it:
Action: Sold to close the PG ($78.40) July 31st weekly 81 put at $2.60 for a $1 profit
[hr]
New Trade: Re-Rated – $PG
Consumer staples, as a sector in the U.S. has been the poster-child for the sort of headwinds facing our multinationals, with many large components like Proctor & Gamble (PG) down 13% from its all time highs made in late December and at one point last month round-tripping the entire 52 week move:
To be fair, the headwinds of dollar strength and exposure by most large staples to weak emerging markets is well known at this point, and PG’s price action shows that investors have tried to price this in. But taking a slightly longer term view the stock is already approaching near term technical resistance. I it was to fail again here, $75 below is a reasonable target on the next leg lower.
Analysts expect earnings and sales to decline 2 and 8% respectively in 2015, while the stock’s earnings multiple remains well above the market and near 7 year highs at 19x expected fiscal 2016 earnings which consensus is calling for 6% growth. The stock is expensive to the market, and its expected growth.
The company is aggressive on the capital return front with a multi-billion share repurchase in place, and a dividend that yields 3.25% annually. Back in April, The Motley Fool (here) had a succinct discussion regarding PG’s recent capital return equaling more than the company’s cash flow in 2014:
This year, the company expects to spend $7.4 billion on dividends, yielding a payout ratio of 73%, assuming free cash flow is flat. With currency headwinds, FCF could easily fall, making the payout ratio even higher. The dividend payout ratio is seen as the best indicator of a company’s ability to fund future dividends, and anything over 80% is generally considered to be dangerous territory. Therefore, P&G’s payout ratio will likely top out around 80%.
To maintain its current level of dividend payments and share buybacks, the company will either have to borrow money, cut expenses elsewhere, or deplete its cash hoard of $8 billion. As the chart below shows, P&G’s dividends have gone up consistently over the past five years, even as earnings per share have fallen.
That kind of pattern is not sustainable. Procter & Gamble’s 3% dividend increase was its lowest in over 10 years, but with currency headwinds, flat organic growth, and cash constraints, that kind of modest increase will likely become the new normal.
With the stock down 13% and headwinds well known, the stock looks like a tough press on the short side (the last time we shorted, back in Jan the stock was in the high $80s, about 10% higher read (here), but this morning’s better than expected results from Pepsi (PEP) a consumer staple with similar characteristics to PG, and the stock’s tepid response suggest to me that PG could be setting up for a re-test of its recent lows on a miss and guide down when they report on July 30th.
Short dated options prices have moved up handily in the last couple weeks, partly a result of the increased volatility in the broad market, but also as expected in front of earnings, with 30 day at them money implied vol (blue below) at 16.6%, at levels of the two prior reports, but a tad below the October highs, a period when the broad market was much lower than current levels, and fear far greater:
I want to target a move back to the 52 week low made on June 8th at $77 and possibly finding support at $75:
Trade: PG ($81.25) Buy July 31st weekly 81 put for 1.60
Break-Even on July 31st weekly Expiration:
Profits: below $79.40
Losses: up to 1.60 between $79.60 and $81 with max loss of $1.60 above $81
Next Move: On a near term move to $80 we will look to turn these puts into a vertical spread by selling the July 31st weekly 77 puts and reduce our premium at risk, and our break-even on the downside. Also long premium directional trades into events are tough, and as usual if we are wrong on the entry here we will look to cut our losses at half of the premium spent.