PepsiCo, Inc. (NYSE:PEP) manufactures, markets, and sells various foods, snacks, and carbonated and non-carbonated beverages worldwide. The company operates in four divisions: PepsiCo Americas Foods (PAF), PepsiCo Americas Beverages (PAB), PepsiCo Europe, and PepsiCo Asia, Middle East and Africa (AMEA). The company is a dividend champion, which has increased distributions for 45 years in a row.
Last week, the Board of Directors approved a 7% increase in the quarterly dividend to 80.50 cents/share. PepsiCo’s largest competitors include Coca Cola (NYSE:KO) and Dr Pepper Snapple Group (NYSE:DPS).
Over the past decade, this dividend growth stock has delivered an annualized total return of 5.20% to its shareholders.
The company has managed to deliver a 2.70% average increase in annual EPS over the past decade. Core earnings have been depressed by weaker international currencies relative to the dollar. PepsiCo is expected to earn $5.14 per share in 2017 and $5.52 per share in 2018. In comparison, the company earned $4.36/share in 2016.
Share buybacks have resulted in the decrease in outstanding shares from 1.686 billion in 2006 to 1.44 million in 2017. A history of consistent share repurchases is helpful, because it shows that the company is willing to help out long-term holders of stock with increased proportional share of earnings and the business over time.
PepsiCo has a wide moat, due to strong recognizable brands it owns, scale of operations, relationships with retailers and having a distribution network of bottlers that will take billions of dollars to create and replicate. Because of the consumer affinity for branded snacks and beverages that PepsiCo makes, they are less likely to switch to a cheaper product. Hence, PepsiCo is part of a sort of unregulated monopoly, which also has some pricing power.
The company has a solid distribution network, a portfolio of strong brand names, and solid relationships with retailers. This portfolio also includes 22 brands with sales of at least $1 billion for each brand. The market dominance in the snack business of Frito-Lay has resulted in higher margins, relative to competitors.
Future growth in earnings will come from international expansion, particularly in emerging markets. The number of servings that consumers abroad consume is much lower than that in North America, which is why I believe there will be years of growth ahead. In addition, I like the fact that the company sells not only beverages, but snacks as well. As an investor, I like to be diversified; hence, I like it when the companies I own are diversified in products and geography. It is estimated that the company achieves significant synergies by operating both a beverage and a snack business.
Earnings can also increase through organic growth for those snacks and beverages, and price increases to offset cost pressures. Strategic cost initiatives to streamline operations, increase productivity and reduce redundancies are another tool to increase shareholder earnings.
Sales of carbonated drinks have been softening, due to increased health awareness by consumers in developed markets. However, PepsiCo has also focused on fast growing non-carbonated soft drinks. The company’s innovation in the area has been successful with the introduction of Aquafina, Gatorade and Propel, Lipton teas and Tropicana.
Future earnings growth could also come from synergies associated with the acquisitions of its bottlers, streamlining of operations and cost cutting. The distribution networks of the bottlers acquired could be used to push some of PepsiCo’s non-beverage products such as snacks and other foods. Earnings growth could also come from other strategic acquisitions, as well as product innovations in health and wellness food and beverage section.
The annual dividend payment has increased at a rate of 10% per year over the past decade, which is higher than the growth in EPS.
A 10% growth in distributions translates into the dividend payment doubling every seven years on average. If we check the dividend history, going as far back as 1973, we could see that PepsiCo has actually managed to double dividends every six years on average. I would expect future dividend growth to be closer to 5% – 6%/year over the next decade.
In the past decade, the dividend payout ratio increased from 42% in 2007 to a little under 67% in 2016. This is a high payout ratio. I generally do not want to see high dividend growth as a result of expansion in the payout ratio. If we look at forward earnings of $5/share, the payout is in the low 60%’s, which is still high. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently, the company is overvalued at 22 times forward earnings and yields 2.80%. It is slightly cheaper than Coca-Cola, which sells for 23.20 times forward earnings and has a current yield of 3.40%. The pure play on North American soda is Dr. Pepper Snapple is cheaper at 19.70 times forward earnings and a current yield of 2.50%.
It looks like PepsiCo has not grown earnings per share by much over the past decade. The one-time hits to the earnings each year make the fundamental analysis I used to perform, using ten year data very difficult. If we look at forward earnings, which themselves could be subject to excessive optimism, the ten year picture looks much more promising. Given the high valuation today, I would give the stock a pass. That being said, it is still a core holding that I will hold on to in my portfolio. However, dividends will be reinvested elsewhere.
Full Disclosure: Long PEP, KO, DPS
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Article by Dividend Growth Investor