Dividend Aristocrats Part 46: PepsiCo, Inc. (PEP) by Ben Reynolds, Sure Dividend
PepsiCo (PEP) is the second most valuable beverage company in the world based on its market capitalization of nearly $140 billion.
You can guess who the largest is…
What sets PepsiCo apart from its slightly larger and slightly more iconic competitor (who shall not be named in this article) is PepsiCo’s snack brands portfolio.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
All 8 of the company’s food brands that generate over $1 billion a year in sales are listed below:
With the name ‘PepsiCo’, you’d think that the majority of PepsiCo’s profits come from sodas (or beverages in general), but that is not the case. PepsiCo generates more than 50% of its operating income from food products, not beverage products.
In total, PepsiCo has 22 brands that generate over $1 billion a year in sales.
These brands were not build overnight… PepsiCo has a long corporate history.
The company’s history can be traced back to 1893.
Pepsi was first sold as ‘Brad’s Drink’ in 1893. The soda was developed by Caleb Bradham in New Bern, North Carolina. In 1898, he renamed his soda – which is just a bit more marketable than ‘Brad’s Soda’. Pepsi Cola gets its name from the digestive enzyme pepsin and the kola nut which was used in the recipe.
PepsiCo (the corporation) was created in 1965 when Frito-Lay merged with Pepsi-Cola. The company has been extremely successful over the last 50 years.
PepsiCo’s long dividend history is evidence of the company’s steady growth. In total PepsiCo has paid increasing dividends for 43 consecutive years.
The company’s long dividend streak makes it a Dividend Aristocrat and subject of part 46 of the current 52 part Dividend Aristocrat series by Sure Dividend.
I am currently long PepsiCo. The first article to appear on Sure Dividend was an analysis of PepsiCo.
There’s little argument PepsiCo is a great business. I believe the combination of a great business and a great purchase price make for a favorable long-term investment.
Is PepsiCo fairly valued at current prices? The ‘valuation’ section below covers the company’s fair value.
PepsiCo stock is currently trading for a price-to-earnings multiple of 20.7 (using adjusted earnings).
PepsiCo has historically traded for a premium of about 1.1x over the S&P 500’s price-to-earnings ratio.
Using PepsiCo’s historical premium multiplier of 1.1x and the S&P 500’s current price-to-earnings ratio of 19.8 implies a fair price-to-earnings ratio of 21.7 for PepsiCo.
PepsiCo is likely trading for around fair value at current prices; the company isn’t a bargain right now (it rarely is), but it isn’t wildly overvalued either.
There are 2 primary reasons why PepsiCo commands a higher price-to-earnings ratio than the average S&P 500 business:
- Safer business model
- Better expected total returns
Lower risk combined with better returns is the ‘holy grail’ of stock selection. Both of these factors are discussed in the following sections in this article.
PepsiCo’s Safety – Volatility & Competitive Advantage
PepsiCo’s stock price is very stable. The company’s stock price standard deviation over the last decade is just 17.5% – one of the lowest of any stock. For context, the only large corporations with 25+ years of dividend payments without a reduction to have a lower stock price standard deviation are:
- General Mills (GIS)
- Southern Company (SO)
- Johnson & Johnson (JNJ)
- Consolidated Edison (ED)
The company’s low stock price standard deviation is a reflection of the safety and stability derived from PepsiCo’s strong and durable competitive advantage.
PepsiCo’s competitive advantage comes from its global operating scale and strong brands. The company’s competitive advantage is extremely durable due to the slow changing nature of the snack and beverage industry.
All 22 of PepsiCo’s brands that generate over $1 billion a year in sales are shown below:
Source: PepsiCo Brand Explorer
PepsiCo builds and supports its brands through large advertising and marketing spending. The company’s advertising and marketing spending over its last 3 full fiscal years is shown below:
- 2014 advertising and marketing spend of $3.9 billion
- 2013 advertising and marketing spend of $3.9 billion
- 2012 advertising and marketing spend of $3.7 billion
PepsiCo’s ability to spend billions of dollars on advertising each year is a competitive advantage that smaller competitors simply cannot enjoy. As a result, the company’s brands are widely known and purchased throughout the world.
PepsiCo’s Safety – Recession Performance
PepsiCo performs well during recessions.
The company’s low priced consumer food and beverage products are in demand regardless of the economic climate.
PepsiCo’s earnings-per-share throughout the Great Recession of 2007 to 2009 are listed below to show the company’s stability through recessions:
- 2007 earnings-per-share of $3.34
- 2008 earnings-per-share of $3.21
- 2009 earnings-per-share of $3.77
PepsiCo’s earnings-per-share experienced only a minor dip through the worst of the Great Recession.
The company actually hit a new earnings-per-share high in 2009 while many other large corporations were struggling to stay profitable.
PepsiCo’s Total Returns – Future Growth Prospects
PepsiCo is targeting 9% constant-currency adjusted earnings-per-share growth in fiscal 2015.
The company is focusing on raising margins through leveraging its global scale and increasing efficiency. To this end, the company has undertaken the following projects (quoted from CEO Indra Nooyi’s 3rd quarter 2015 earnings call)
“We have installed packaging automation across approximately a third of our snacks plants worldwide, enabling us to reduce packaging label costs in these facilities by at least 50%.”
“We are restructuring our go-to-market systems. Since the success of our Perry, Georgia, pilot in 2009, we have expanded our geographic enterprise solutions or GES as we call them at Frito-Lay North America to a total of 11 projects, which are now at various stages of deployment across locations in both the US and Canada. The consolidation of this plant and distribution networks will result in scale that enables economic implementation of automated order picking, the reduction of distribution centers and a highly efficient direct-to-store delivery system directly from our plant.”
“We’re optimizing our global manufacturing footprint. Since 2010, we have reduced the number of company-owned beverage plants in North America by 23%. At the same time, we’ve increased our capacity utilization by 20%.”
PepsiCo’s efficiency programs are working. The company has increased operating income per employee by 9% in the last 3 years.
The company’s long-term growth driver is global population growth and continued global expansion. PepsiCo currently generates 62% of its operating income in North America.
This means that the company has only just begun to tap the potential of international markets for its products. Over the long run, PepsiCo will grow as long as it is able to build (or acquire) brands that consumers want to eat and drink. Global population growth will drive long-term demand for food and beverages.
PepsiCo’s Total Returns – Expected Total Returns
PepsiCo has grown earnings-per-share at 4.7% a year over the last decade.
While this level of growth is not terrible, it isn’t in line with what investors should expect from PepsiCo. PepsiCo should be able to manage faster earnings-per-share growth over the next several years.
I expect PepsiCo to generate earnings-per-share growth of 7% to 9% a year over the next several years from the following sources:
- Share repurchases of 1.5% per year
- Margin expansion of 2% to 3% per year
- Revenue growth of 3.5% to 4.5% per year
In addition to earnings-per-share growth, PepsiCo also pays a 2.9% dividend yield. The company’s near 3% dividend yield combined with 7% to 9% expected earnings-per-share growth gives investors in PepsiCo expected total returns of 10% to 12% per year over the next several years.
Final Thoughts on PepsiCo
PepsiCo is a high quality business with a long history of strong growth and solid future growth prospects.
The company’s underlying businesses remain healthy, and the stock appears to be trading around fair value at current prices. PepsiCo is ranked in the Top 25% of long-term dividend stocks using The 8 Rules of Dividend Investing.
The company’s solid expected growth, above average yield, and low stock price standard deviation make PepsiCo a low risk investment with double-digit total return potential.