When was the last time you drank a can of cola or a bottle of water?
Ate a bag of potato chips? Made oatmeal for breakfast?
Well, I’m willing to bet that at some point in your recent past (or maybe right now?) you used one of these products. And that’s because people like to eat chips and oatmeal, and they like to drink beverages.
But do you know what these types of food products have in common?
PepsiCo, Inc. (PEP) produces and provides all of these food products, and many more.
How could you not want to profit from that?
Oh, you do want to profit from that?
Well, let me tell you how!
PepsiCo, Inc. is an international food and beverage company that manufactures and markets a range of foods, snacks, and beverages in more than 200 countries across the world.
The company operates in six segments: North America Beverages (34% of 2016 revenue); Frito-Lay North America (25%); Europe Sub-Saharan Africa (16%); Latin America Foods (11%); Asia, Middle East, and North Africa (10%); and Quaker Foods North America (4%). Approximately half of their revenue is generated via beverages, and the other half is generated via food products.
That already tells you a lot, but there’s much more to the story.
PepsiCo might be most well known to many people by their namesake cola, but they have a lot more to offer than that.
Think Quaker Oats, Gatorade, Tropicana juices, Aquafina bottled water, Lipton tea, Lay’s potato chips, Tostitos tortilla chips, Doritos, Mountain Dew, Sierra Mist, and Fritos corn chips, among other brands and products.
They have twenty-two $1 billion brands.
These are all brand names known around the world. And these are all products that people across the globe enjoy every single day. And this is why it’s highly likely this company will not only still be around a decade or more from now, but will also be more profitable, which will mean they can send out even more cash to shareholders. And who doesn’t like more cash?
This beverage and snack giant has faced some growth challenges over the last decade, but they’re still positioned very well for the future. Their fiscal year ends December 31.
Revenue has grown from $39.474 billion in FY 2007 to $62.799 billion in FY 2016. That’s a compound annual growth rate of 5.29%, which is really solid for a mature business like this.
Earnings per share is up from $3.41 to $4.36 during this same time period. That’s a CAGR of 2.77%.
That bottom-line expansion is a little disappointing, as PepsiCo has had to deal with margin pressure, currency exchange headwinds, and some larger trends away from certain foods and beverages they produce. Moreover, the last 10 years have been economically tough for many regions of the world.
Looking forward, professional stock analysis firm CFRA believes PepsiCo will compound its EPS at an annual rate of 8% over the next three years, which would actually just be a return to more historical-like growth for the food and beverage giant.
I’m a dividend growth investor. As such, one of my primary concerns is receiving a growing dividend from a company. And PepsiCo doesn’t disappoint.
This company is featured on David Fish’s Dividend Champions, Contenders, and Challengers list. That’s a document that tracks stocks with at least five years of consecutive dividend raises. And PepsiCo is a “Champion”, baby!
PepsiCo has increased its quarterly per share dividend for the last 45 consecutive years.
And over the last decade, the dividend has grown by an annual rate of 10.0%.
We can see a pretty large difference between EPS and dividend growth over the last decade, which means that Pepsi has been fueling a large chunk of their dividend growth via an expansion of their payout ratio.
At 66.5%, the payout ratio is still reasonable. But there’s less opportunity for the company to produce outsized (relative to EPS growth) dividend growth moving forward, which means dividend growth and EPS growth will likely have to match one another.
But if CFRA’s prediction holds true, dividend growth should remain pretty strong moving forward.
Meanwhile, the stock yields a very healthy 2.7% right now.
That’s much higher than what the broader stock market yields, so you’re getting an above-average yield backed by almost two dozen of the biggest and best consumer brands in the world.
The balance sheet might seem terribly leveraged at first, but that’s largely because shareholders’ equity looks lower than it is due to a lot of treasury stock skewing the numbers.
The long-term debt/equity ratio is 2.67, but the interest coverage ratio, at over 7, indicates no issues with PepsiCo’s ability to cover its interest expense.
That said, there’s been some modest deterioration in the balance sheet recently. Resuming back to normal growth will help PepsiCo alleviate this.
The company’s profitability is solid, but there’s some room for improvement here.
Over the last five years, PepsiCo has averaged net margin of 9.61% and return on equity of 36.22%.
I don’t know how you can’t like investing in a company like this.
I suppose that’s why PepsiCo is one of the largest investments in my portfolio — a portfolio that generates enough passive dividend income for me to live off of.
Twenty-two $1 billion brands, wide diversification in products and countries, massive economies of scale, and a global distribution network means they can produce high-quality products for less than almost all of the competition.
And they’ve already got the snack aisle pretty much locked down. Walking down a snack aisle at your local grocery store will show you pretty much nothing but PepsiCo products. Then walking over to the beverage aisle will show you that they’ve got about half that aisle covered.
Dominating the space like this gives PepsiCo a ton of competitive advantages. It’s just extremely difficult for a new player to get a foothold in the market when there’s little or no space in a grocer’s aisles for their products. And this dominance means it’s likely that PepsiCo will continue to profit for many years to come.
Of course, there are risks.
There has been a softening in demand for carbonated soft drinks over the last few years in developed countries. And PepsiCo still derives a significant portion of their revenue from soft drinks. This trend is primarily a health issue, as more people are concerned with general health, and more specifically their sugar and caloric intake.
In addition, while the company maintains a solid competitive position, competition is fierce in beverages and snacks.
And they also face exposure to commodities, especially corn. Rising costs there can have a material adverse effect on the business.
PepsiCo shares are trading for a price-to-earnings ratio of 24.3 right now. That’s above the stock’s own five-year average P/E ratio of 21.8. It’s not surprising to see a stock like this trading at a valuation above its recent historical average, as the broader market as a whole has been on an incredible run over the last few years. That said, the stock looks a bit rich here, especially considering the growth challenges the company has experienced.
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 6.5%.
That growth rate factors in the elevated payout ratio, the 10-year EPS growth rate, and more recent dividend growth. A return to historical profit growth could help PepsiCo exceed this expectation, but I like to err on the side of caution.
The DDM analysis gives me a fair value of $97.98.
Bottom Line: PepsiCo, Inc. (PEP) provides the beverages, food, and snacks that billions of people all over the world enjoy. They sell products in more than 200 countries, and have twenty-two $1 billion brands. A great competitive position means they’ll likely be able to leverage their past success into future success. And I think they’ll continue to pump out more and more profit for decades to come, which will fund even greater dividends to shareholders. But considering my fair value estimate, investors may want to wait for a pullback below $98 before buying the stock.
— Jason Fieber
P.S. If you’re looking for a high-quality dividend growth stock that appears to be 21% undervalued right now, take a look at this week’s Undervalued Dividend Growth Stock of the Week.