P&G Looks for a Buyback Boost

The cash-rich consumer products giant lifts its repurchase authorization to an eye-popping $30 billion

With an 8% increase in sales and a 22% jump in profit in the latest quarter, Procter & Gamble (PG) can hardly be called a laggard, but compared with some of its consumer-staples peers, its growth rate is leaving investors cold.

That may be part of the rationale behind the Cincinnati-based company's decision to dramatically boost its share repurchase program to between $24 billion and $30 billion over the next three years.

The manufacturer of Crest toothpaste, Gillette razors and scores of other well-known household products posted a 22% gain in earnings for its fiscal fourth quarter to 67 cents a share from 55 cents a share a year ago, driven by an 8% rise in sales to $19.3 billion. Sales for its long-owned product lines rose 5%, the lower end of its 5% to 6% estimated range.

But the expansion of the buyback program was the bigger news on Aug. 3. The new level amounts to $8 billion to $10 billion in shares to be repurchased, versus the $5.6 billion in shares the company plans to buy back in fiscal year 2007.

Investors chose to focus, however, on a weaker-than-expected earnings forecast of $3.44 to $3.47 a share for fiscal 2008, which falls short of Wall Street's $3.48 consensus. Shares were trading 0.2% lower in the early afternoon of Aug. 3, despite the fact that Procter & Gamble is known for being conservative in its profit guidance and has a history of beating its own forecasts.

In view of a fairly high dividend and a lack of acquisition opportunities, hiking the level of stock buybacks is probably the best use of the company's plentiful free cash flow, said Joe Altobello, an equity analyst at CIBC World Markets. (CIBC doesn't do investment banking with the company.)

In fiscal 2007, it generated free cash flow of roughly $10.5 billion before dividends, and more than $6.0 billion after capital expenditures and dividend payouts, he said. He didn't see the increased volatility in the equities market as playing a part in the buyback expansion.

Besides bowing to pressure from investors who have been pushing companies like Procter & Gamble that are flush with cash to increase share buybacks, the company realizes the stock is incredibly undervalued at this point, said Nik Modi, an equity analyst at UBS Investment Research. (UBS has done investment banking with Procter & Gamble and made a market in its securities in the past three years.)

A third reason for accelerating the buybacks may be to offset higher projected charges from its internal restructuring efforts being implemented to make the company more agile and profitable in the future, Modi said. Procter & Gamble has been absorbing the charges - for things like information technology upgrades and severance packages for headcount cuts - on an ongoing basis instead of in one big package, he added.

The company doubled its estimate for restructuring costs in fiscal 2008 to $400 million from $200 million, and analysts are factoring that into their earnings forecasts, as the company has requested, Modi said. He figures that will shave four to five cents off annual earnings for fiscal 2008.

He calculates that the increased share buybacks will boost earnings by four cents a share, as opposed to the company's estimated one-penny contribution, a number he says he's still trying to understand.

Accelerating share repurchases make sense in light of the company's lacking a catalyst right now to get investors excited and the fact that "the market's not interested in slow and steady gainers," senior research analyst John Faucher at JP Morgan Securities said on CNBC Business News.

"Two years ago, this company could do no wrong," with organic sales growing at of 8%, which fell to 5% in the latest period, said Altobello at CIBC. "Other companies like Colgate have taken the lead in the staples growth area, and we see investment capital flowing to them and away from Procter."

The stock was off 4% year-to-date through the end of July, but shares have perked up in the latter part of this week.

One advantage Colgate Palmolive (CL) has is the stake it's claimed in developing markets such as Latin America, Altobello added.

The marketing investment Procter & Gamble would need to make in order to win a significant market share in these markets is too expensive at this point. Colgate has more than an 80% market share in oral care products in Mexico and when Procter & Gamble tried to make inroads there recently it got beaten back, Altobello said.

"Even though Crest has lot of market share in the U.S., that doesn't translate to a market like Mexico," he said.

Nor does the company have any attractive acquisitions prospects, an alternative use for its free cash flow. In fact, on its conference call to discuss the latest earnings, it said it would more likely be a seller than a buyer of assets.

Slower-growth, lower-margin businesses such as snacks, coffee and pet care, or the Duracell Braun battery unit would probably be the first to go, he said. Its pet food business seems to have hit a wall in terms of growth, with its Iams brand recently losing two percentage points in U.S. market share to 11%, he explained.

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