The PepsiCo stock: Fizzy profits with dividend topping?

PepsiCo stock
Logo
Country	USA
Industry	Food/Beverages
Isin	US7134481081
Market cap.	196.9 billion $
Dividend yield	2.9%
Dividend stability	0.99 of max. 1.0
Earnings stability	0.95 of max. 1.0

The price of the PepsiCo stock has gone up 50 percent in the past 5 years, beating its main competitor Coca-Cola which only went up 31 percent.

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48 years of consecutive dividend increases make Pepsi a dividend aristocrat like Coca-Cola. On top of that the company outperforms Coca-Cola when it comes to growth rates in both profit and cash flow.
Despite these facts, the Coca-Cola stock receives a lot more attention in the financial community. This might be a result of Warren Buffett’s investment in Coca-Cola. In this stock analysis, we will shed light on the Pepsi Stock and show you what Coca-Cola´s competitor has to offer.

The business model: This is how Pepsi earns its money

PepsiCo is an American producer of snacks and beverages headquartered in New York. The company was formed in 1965 through the merger of the Pepsi-Cola Company and Frito-Lay Inc. The CEOs recognized the value of a company that could offer both snacks and beverages, as these products are often consumed together. This symbiosis can still be seen in the revenue breakdown today. Each product division accounts for about half of the revenues.

Revenues of Pepsi by segment (Source: PepsiCo)

The portfolio of Pepsi consists of a wide variety of brands distributed through wholesale, brick and mortar retail and online retailers. Some of the well-known brands like Pepsi, Sodastream, Mountain Dew or Doritos are probably familiar to you.

Brands of Pepsi (Source: Brandovate)

23 of those brands each manage to bring in more than a billion USD in yearly revenue.

Brands of Pepsi with more than a billion in annual revenue (Source: PepsiCo)

Competitors of Pepsi

The most obvious competitor of Pepsi is Coca-Cola. Do you know someone who is a die-hard fan of either one of these and absolutely refuses to drink the other brand? I would guess that a lot of people do. Despite the similarity of the two soft drinks, most consumers are very loyal to their favorite brand. Nevertheless, the two companies are still fighting for market share in this segment. In the food and snack business, Pepsi also competes with Kellogg, Nestle, Kraft-Heinz, Mondelez, Campbell Soup and Conagra Brands.

Competitors of Pepsi (Source: Dividendstocks.cash)

With a P/E ratio of 26 and a dividend yield of 3.1%, the Pepsi stock is quite similar to Coca-Cola. The figures for the rest of the group also look similar, with the exception of Campbell-Soup and Kraft-Heinz. The overall high P/E ratios reflect the above-average earnings stability which is common in this industry. Since investors are willing to pay for safety, the profits of these companies are rewarded with higher P/E ratios, which results in a higher stock price.

How profitable is Pepsi?

The food and beverage industry is not known for its high growth rates. Generally, these are established companies with organic growth in the low- to mid-single-digit range. Organic growth is a combination of high prices and volume growth, which can be driven by new products and entries into new markets. However, gaining market share can be difficult. Since most companies have a wide variety of products in their portfolios, increasing the market share for one product usually has just a very modest effect on the overall revenue growth.

Pepsi is not exempt from this rule. While it is true that Pepsi was able to increase its profit by 7 percent annually over a 5-year period, over a 10-year period, the growth rate was only 2.7 percent annually. A similar case applies to the operating cash flow with 7.5 percent annual growth over the last 5 years, but only 1.7 percent over the last 10 years. The dividend has increased by about 8 percent annually in both periods. You should not expect Pepsi to grow at double-digit rates in the long term.

Profits, cash flows and dividends of the Pepsi stock

Revenue growth rates have generally behaved similarly, and large revenue increases are usually the result of acquisitions. In the last 10 years, Pepsi’s revenues have grown by just 1.8 percent per year. Profitability has also hardly changed during this period. Since 2011, the operating margin has hovered around the 16 percent mark. You therefore should not expect any sudden changes from Pepsi. Some investors may dislike this aspect, as it means that there likely will not be any sudden positive changes that result in a big jump in the stock price. Other investors on the other hand, appreciate the earnings stability and the fact that the business model is resilient even in difficult times like these. Furthermore, the business model will most likely be viable for several decades.

Revenues and operating margin of the Pepsi stock

How safe is the dividend of Pepsi?

Pepsi pays its dividend on a quarterly basis. Following the recent increase of 7 USD cents to 1.02 USD, Pepsi now pays 4.08 USD per year. At the current stock price, this translates into a dividend yield of 3 percent. Most impressively, Pepsi has increased its dividend for 48 years straight which qualifies the company as a dividend aristocrat.

PepsiCo Dividend History

Is the current yield high or low based on historical standards? In the Dividend Turbo on Dividenstocks.cash, you can see that the dividend yield of Pepsi has been surprisingly constant over the last 10 years. The current yield of 3 percent is only slightly higher than the 12-month average of 2.85 percent. From a dividend point of view, the stock appears to be fairly valued right now.

Pepsi in the Dividend Turbo

A dividend yield of 3 percent is quite decent. Especially when you consider that the dividend has been increased by an average of 8 percent annually over a 10-year period. At this rate, a dividend yield of 3 percent will quickly turn into 4 or 5 percent. To ensure future dividend increases, sustainable long-term profit growth is necessary. Moderate debt and a low payout ratio also provide a buffer in bad times. Does the Pepsi stock satisfy these requirements?

Looking at the numbers on Dividendstocks.cash, you can see that Pepsi has steadily grown over the long term. Revenues and profits are also expected to grow in the future. Additionally, neither profit nor cash flow has ever taken a sharp decline during the past two decades. This is not particularly surprising for this industry. Even a global catastrophe like the Covid-19 pandemic could not harm the business model of Pepsi. The dividend is well protected from an earnings perspective. However, payout ratios on both profit and free cash flow have increased in recent years and are currently sitting at just under 80 and 86 percent respectively. Nevertheless, I see no reason for concern here. I consider a major drop in earnings to be unlikely. Furthermore, earnings are expected to grow according to analysts which will bring down the payout ratio again.

Profits, cash flows and payout ratio of the Pepsi stock

Pepsi’s debt looks a little disconcerting at first glance. The total debt amounts to over USD 78 billion. However, if you take a look at the latest quarterly report (page 7), you will notice that only about half of this debt is interest-bearing. In the past year, interest has eaten up 11 percent (page 73) of the operating profit, which is acceptable and does not pose a threat to the dividend.

Indebtedness of Pepsi

The dividend of Pepsi is safe in my opinion, but what about future increases? To enable dividend increases the profit has to rise long-term. According to the analysts’ estimates on Dividendstocks.cash, this is the case. Both profit and cash flow are expected to increase in the coming years. Personally, I only expect low- to mid-single digit dividend growth in the long-term. I base my assumption on the fact that the food and beverage market does not display high growth rates, which is reflected in Pepsi’s numbers from the past 10 years.

In the long term, dividend increases must come from profit and cash flow growth. In the short to medium term, however, increases can also be financed out of the amortization power (i.e. an increase in the free cash flow based payout ratio). Currently, the amortization power of Pepsi is not high enough to support this.

Amortization power of Pepsi

There is a good reason for this drop as you can see in the annual report of 2019. The columns show the years from 2017 to 2019 from right to left. Pepsi spent a lot more money on acquisitions in 2018 and 2019 than in 2017. Acquisition expenditures are usually non-recurring which means that the free cash flow and consequently the amortization power should rise again in the future.

Investment expenditures of Pepsi (Source: 2019 Annual Report)

To summarize the arguments of this chapter: In my opinion, the dividend of Pepsi is safe and will continue to increase in future. In the short to medium term, higher growth rates might be possible, but in the long term, you should expect growth in line with long-term profit growth.

Pepsi vs. Coca-Cola

The main difference between Pepsi and Coca-Cola is that Coca-Cola is purely a beverage company, while Pepsi generates about half of its sales with snacks and other food products. Nevertheless, from a shareholder perspective, the two companies have many similarities. Both companies are dividend aristocrats and therefore suited for dividend investors. In terms of profitability, Coca-Cola is ahead of Pepsi, with an operating margin of 27 percent, well above that of Pepsi, which is only 15 percent. When it comes to growth, however, Pepsi is the clear winner. I personally think that both shares fit very well into a dividend portfolio and would make my decision based on the valuation of the stocks.

Pepsi versus Coca-Cola

Is the Pepsi stock fairly valued?

Due to its fairly stable and predictable earnings, the Pepsi stock is well suited for a valuation using historic multiples. I have chosen a 5-year period because the P/E has been higher in the past 5 years that it has been prior to this time frame. If we chose a longer period, the fair value would be pulled down by the lower P/E ratio of earlier years. Since I do not see any indication why the market should value Pepsi’s earnings at a significantly lower P/E ratio in the near future, I believe the last 5 years to be the optimal valuation period.

For this period, the fair value dividend is almost identical to the current price, while the other fair values are lower. In general, the dividend yield would be a suitable valuation indicator. However, this fair value has been influenced by the increase in the payout ratio. Since these increases cannot continue forever, I would rather base my calculations on the other fair values. These are very close to each other, but also well below the current stock price. The price of the Pepsi stock is USD 138, and so is the fair value dividend. The fair values for profit and cash flow are significantly lower at USD 123 and USD 126. Therefore, the Pepsi stock is slightly overvalued right now.

Pepsi in the Dynamic Stock Valuation

In my opinion, the competitor Coca-Cola is more attractively valued. Its dividend fair value is more meaningful, because its payout ratio has not been significantly increased this year. The profit fair value for the Coca-Cola stock is also a lot higher than the current price. Admittedly, the cash flow fair value signals an overvaluation. However, this is an anomaly in this year, as you can see from the trajectory of the curve.

Coca-Cola in the Dynamic Stock Valuation

Conclusion: The Pepsi stock – Quality has its price

The Pepsi stock is rarely cheap, like all other high-quality blue-chip stocks. Since profits in this sector are very stable, there are hardly any unpleasant surprises and sudden price drops are therefore very uncommon. Especially in times of uncertainty these stocks can be quite expensive as investors flee into these names in search of safety. Despite the high quality of the company, the Pepsi stock is currently too expensive in my opinion. Dividend investors could put the Pepsi stock on their watchlist and wait for one of the rare opportunities to buy it at a lower price. A crash resulting from a second wave of Covid-19 would be such an opportunity. For other shareholders, a savings plan might be more suitable to take advantage of the dollar cost averaging effect.