On February 13th of 2014 PepsiCo (PEP) announced – in addition to earnings – its expected returns to shareholders in the coming year, an update on the North American Beverage business, an extension of the productivity savings plan and guidance. As an overview, PepsiCo’s earnings beat consensus estimates; the company increased the dividend by 15%, announced a $5 billion share repurchase program, decided the beverage business was still lucrative and said that the company was going to make more money in the future. So how did the stock react to the news? Well, it went down a couple of percent – naturally.
Now, obviously prices are based on future expectations and thus they are much more volatile than the underlying business results. To be fair, we suppose that we should mention the company’s revenues slightly missed expectations. Yet in our view, this is effectively a non-event – if you need to change your assumptions about a company’s underlying business based on a 3 cent per share revenue difference, then perhaps your time horizon is a bit too short.
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Perhaps more to the point of this price decline could have been PepsiCo’s comments about keeping the North American Beverage business – many have been pushing for a separation of the beverage and snack businesses. Perchance the stock price might have gone up had a spin-off announcement been made, but that idea is neither here nor there, or even a possibility at this point. Specifically, PepsiCo had this to say about holding onto the North American Beverage (NAB) business:
“After an exhaustive review, which included the assistance of bankers and consultants, the company’s management and board of directors have concluded that PepsiCo will maximize shareholder value by retaining NAB in its current structure within the PepsiCo portfolio.”
Analysts might not have liked this news, but personally we don’t find too much fault here and applaud the company for actually following up on investor requests. Instead of brushing off some investor’s call for action, PepsiCo said “we’ll review this and get back to you.” They reviewed it and concluded that the best action for shareholders would be to hang on to the world’s second largest beverage maker and continue to utilize the massive distribution scale that it provides. Oppose the decision if you will, but it’s hard to argue with the idea that people with decades more experience in the industry than you took a long hard look and concluded this was the best course of action. Considering that the company’s insider roster has almost a quarter of a billion dollars wrapped up in PepsiCo stock it stands to reason that the people making the decisions have a bit more vested interest than an analyst without a position or your neighbor with 100 shares.
But alas, we will never know the true psychology of Mr. Market.
With the above being stated, let’s take a look at PepsiCo from the view of a current or potential investor. Below we have included a 13-year Earnings and Price Correlated graph of PepsiCo as presented using F.A.S.T. Graphs™. Here we can see that PepsiCo has been a very consistent operating company – increasing earnings (orange line) by about 8% over this period. In addition, note that the dividend (pink line and light blue shaded area) has been overwhelmingly persistent. In fact, the company has not only paid but also increased its dividend for 42 straight years. Finally, we can observe that PepsiCo has generally traded above its price-to-earnings ratio of 15 – with its “normal” P/E over this time period being around 19.
Interestingly, if we view the company based on operating cash flows, an even stronger correlation can be observed. We see the same relative growth and persistent dividend, but note how shares of PepsiCo have generally traded in line with a multiple of about 15 times operating cash flow. Based on this metric, PepsiCo also appears to be reasonably in line with how the market has historically priced the company.
By viewing the historical relationship between PepsiCo’s price and relative valuation, it seems that PepsiCo is trading in a very reasonable range. That is, shares are not disproportionately out of sync with history, and thus, one might expect future results to more or less track business results over the long-term.
Therefore, the next question is: what are PepsiCo’s potential prospects moving forward?
The previously cited announcement does provide a solid baseline to begin. We know that PepsiCo expects to put approximately $8.7 billion towards rewarding shareholders via dividends and share repurchases this year. Specifically, the company announces a 15% dividend increase to $2.62 per share starting in June and a $5 billion share repurchase expectation.
On the dividend front, this is excellent news for the income investor – this June you will begin to receive 15% more money from the same exact shares that you held last year. Although we can’t be certain, we would imagine that these types of raises are a bit of a rarity at your day job. Based on today’s price this indicates a 3.3% yield, which is near the upper range of where the dividend yield has historically been.
With regard to share repurchases, $5 billion is roughly 4% of the company’s outstanding market capitalization. Said differently, if future shares bought trade close to today’s prices and stock options are limited, PepsiCo would be able to increase earnings per share by about 4% even if net total profits remain stagnant. Below we have included a chart of PepsiCo’s common shares outstanding (csho) since 2003. Here we see that PepsiCo has been able to reduce outstanding shares from about 1.75 billion in 2002 to today’s number closer to 1.53 billion.
Also in the recent announcement, PepsiCo indicated that it had a long-term target of “high-single-digit” constant currency EPS growth. Pair this with a long-standing commitment to repurchase shares and it doesn’t seem all too difficult to imagine that the company might be able to grow earnings per share by a reasonable – yet still single digit – growth rate moving forward.
Below we have included the Estimated Earnings and Return Calculator. Here, analysts have come to a consensus long-term growth rate of 7.8% – which appears quite reasonable in comparison to other data source estimates. In addition, the next 3 fiscal years of EPS estimates are included. If earnings materialize as forecast, and PepsiCo trades at 15 times earnings in 5-years time, this would indicate an annual estimated total return of 8.9%.
Now, it’s paramount to underscore the idea that this is simply a calculator. However, it does provide a solid guide for how analysts are presently viewing this company. As it stands, the performance returns as presented from the calculator are in line with the expected business results. Yet if PepsiCo trades at a higher multiple in the future, this could indicate performance results that are greater than business results.
In sum, we believe that PepsiCo is an enormously successful company that has demonstrated its continued ability to reward shareholders. The company has not only paid but also increased its dividend for 42 straight years, and has been able to reduce shares outstanding as of late. In addition, the operating results of the company have been solid and are expected to continue into the future. Although some might be discouraged by the decision not to separate the snack and beverage businesses, we believe that there are worse things than owning two of the most powerful operations on the planet. PepsiCo is presently trading in line with its historical valuations and might be offering a reasonable – albeit not necessarily screaming – opportunity moving forward. However, as always, we recommend that the reader conduct his or her own thorough due diligence.
Disclosure: Long PEP at the time of writing.