PepsiCo: Q1 2021 Update

by The Compound Investor

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 back then, 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 circa 11.5% including dividends. The investment case remains pretty much unchanged.

Buy-And-Hold Case

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 Coke, 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 markets. The firm sports huge leading positions in the potato and tortilla chip markets in a bunch of countries, including in the US.

(Source: PepsiCo 2020 CAGNY Presentation)

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 results in pricing power and cost advantages due to its large market share. Snacks display similar characteristics, but here PepsiCo benefits from simpler production and an even larger market share.

All said and done, the above leads to one very profitable business. Returns on invested capital have averaged around 18.5% over the past few years, and it is hard to see that figure eroding any time soon. That means plenty of cash is on the table for things like dividends and stock buybacks. It won’t come as news to read that PepsiCo is a very popular stock among dividend investors due to its record of reliable growth.

COVID

Whether for good or for ill, most firms have seen an impact from COVID on their results. PepsiCo is no exception in that sense, though the firm has benefited versus the likes of 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% in 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 contributed half of EBIT last year between them.

Meanwhile, PepsiCo Beverages North America (“PBNA”) saw organic sales rise 3%. CSD volume fell 5% which led to a 2% decline in beverage volume overall (with CSD volume declines offset by positive growth in non-CSDs). 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 beverage volume fell 2% in organic terms, offset by 4% growth in snacks and 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.

Valuation

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 an aggressive multiple by any stretch. For one, a circa 4.2% earnings yield – that is, the inverse of the PE ratio – is supported by interest rates and PepsiCo’s high quality earnings. Most importantly, growth prospects here remain reasonable. While the firm 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. Indeed, ex-US still only represents a third of EBIT here.

Like many firms, PepsiCo has seen 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 a steady 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.

Note

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