PepsiCo (PEP) stock last appeared on the site back in April. At the time, the snacks and beverage giant had just released financial results covering its first quarter. The numbers came in strong, with organic sales growth at just under 8% and profit per share (“EPS”) growth at 10% versus the prior year. The shares traded for $132 each at the time, equal to around 24x prior-year net profit. I viewed that as justified based on a combination of high single-digit underlying EPS growth, a 3% dividend yield and the low interest rate environment. Since then, the stock has returned roughly 11.5% including dividends. The investment case remains pretty much unchanged.
Though often viewed alongside peer Coca-Cola, PepsiCo sports a different business model. For one, and despite its namesake, most business no longer comes from beverages. Food – led by savory snack brands such as Lay’s and Doritos – generates over half of net revenue here, and a bigger slice of operating profit (“EBIT”). Unlike number one player Coca-Cola, Pepsi’s beverage operations typically involve more than simply producing the concentrate and selling that to bottlers. It is higher cost as a result, and less profitable than Atlanta-based Coke. Its snacks business, on the hand, is simpler and operates with a higher share of its underlying markets. The firm sports huge leading positions in the potato and tortilla chip markets in a bunch of countries, including in the US.
Ultimately, the firm benefits from the strength of its brands, nearly two dozen of which generate annual sales in excess of $1B. Though not as profitable as Coke, PepsiCo still commands a large share of the carbonated softs drinks (“CSD”) market via Pepsi. Serious competition from discounters and store-owned brands is tiny as consumers remain product loyal based on taste. That gives the firm pricing power as well as cost advantages stemming from its large market share. Snacks display similar characteristics, but here PepsiCo benefits from simpler production and an even larger market share.
The above ultimately leads to one highly profitable business. Returns on invested capital have averaged around 18.5% over the past few years, and it is hard to that figure eroding any time soon. That means plenty of cash is on the table for things like dividends, stock buybacks, acquisitions and so on. It won’t come as news to read that PepsiCo is a very popular stock among dividend investors due to its record of reliable dividend growth.
Whether for good or for ill, most firms have seen an impact from the COVID pandemic on their results. PepsiCo is no exception in that sense, though the firm has benefited versus certain peers like Coke due to lower on-premise exposure across its business, especially in snacks. For instance, Frito-Lay North America (“FLNA”) saw organic revenue rise 6% over the first three quarters of FY20. That came on the back of 4% volume growth. Quaker Foods North America (“QFNA”) reported double-digit organic sales growth, driven by 12% volume growth, over the same period. FNLA and QFNA collectively contributed half of EBIT last year.
Meanwhile, PepsiCo Beverages North America (“PBNA”) saw organic sales rise 3%. CSD volume falling 5% led to a 2% decline in beverage volume overall (with CSD volume declines offset by positive growth in non-carbonated beverages). PBNA contributed 20% to operating profit last year. Beverages volume declined in all of the firm’s divisions in organic terms, the sole exception being Europe. Total company-wide organic beverage volume fell 2%, offset by 4% growth in snacks/food. Organic revenue increased 3.6%, with equal positive contributions from volume and net pricing. Constant currency core EPS rose 2% to $4.05 per share.
PepsiCo’s valuation is more or less unchanged since it last appeared on the site. Then, the stock traded at circa $132 per share, or roughly 24x estimated FY20 profit of $5.50 per share. The shares closed yesterday at around $144.30, roughly 24x estimated FY21 profit of $6 per share. That does not strike me as a particularly aggressive multiple by any stretch. For one, a circa 4.2% earnings yield – that is, the inverse of the PE ratio – is supported by ultra-low interest rates and PepsiCo’s high quality earnings, as set out above. Most importantly, PepsiCo’s long-term growth prospects remain reasonable. While it faces headwinds – particularly in terms of CSDs in mature markets – snacks have better prospects. Per capita consumption of its products also has plenty of room to grow outside the US. Ex-US still only represents a third of EBIT here.
Like many firms, PepsiCo has seen foreign currency movements hit USD reporting figures in recent years. That was shaving off mid-single-digits per annum from EPS between FY14 and FY16. As a result, core EPS grew at a CAGR of around 3.5% between FY10 and FY19. Currency neutral core EPS grew at a high single-digit clip in the six years before COVID. On that basis, high single-digit per annum total returns strike me as a conservative assumption. That comes from an unchanged valuation multiple, 2.8% current dividend yield (based on a $4.09 per share annualized dividend) and at least mid-single-digit EPS growth. The latter clocking in at a high single-digit clip would push returns up into the double-digit area.
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