PepsiCo: A Reliable Stalwart Stock According to Peter Lynch Checklist

Author's Avatar
Dec 19, 2014
Article's Main Image

Former Fidelity Magellan fund manager Peter Lynch classified stalwart companies as those with large market capitalizations that provide reliable and predictable growth. These stable companies won’t be ten-baggers for a portfolio, but they can help mitigate risk in times of uncertainty.

The Peter Lynch Stalwart checklist is included as one of GuruFocus’ pre-existing checklists to aid in the research process. The set of 18 questions can help determine whether a company has the business stability to act as cornerstone of a portfolio.

PepsiCo (PEP, Financial) is one such stalwart that we’ll examine using the checklist. Read the analysis of PepsiCo’s main competitor Coca-Cola (KO, Financial) here.

Does the company have a diversified customer base?

PepsiCo’s brands span a variety of categories, from healthier snack and drink options to well-known “junk food” brands. The company website categorizes its products in three areas: Fun for You brands include Fritos, Lays and Cheetos; Good for You brands include Naked Juice, Aquafina and Gatorade; while Better for You foods include Baked Lays and Propel Zero.

With a diversified list of products, PepsiCo can appeal to a wide consumer base. Its products are sold in more than 200 countries.

Does the company still have room to grow? Has the company duplicated its successes in more than one city or town to prove that expansion will work?

Though PepsiCo is already present in most countries of the world, the company can continue to acquire new food and beverage brands.

The company has paid attention to differing tastes across regions and customized its products to fit the market. For example, PepsiCo is the largest food and beverage company in Russia, where it recently introduced new flavors of Chudo drinkable yogurt.

PepsiCo’s brand portfolio also includes items that can people can consume at different parts of their day, such as Quaker oatmeal in the morning, Pepsi during lunch, and Lipton tea in the evening.

Does the company have meaningful profit margin (10% or higher)?

PepsiCo’s profit margin narrowly met Lynch’s standards at 10.15% in FY 2013, though its margin in the most recent quarter was 11.66%.

03May20171227241493832444.png

In the 2013 annual report, PepsiCo reported that total operating profit increased 7% year-over-year, and operating margin increased 0.7 percentage points due to effective net pricing and cost reductions.

Does the company have a higher margin than competitors?

PepsiCo’s largest competitor in the beverage category is Coca-Cola, whose profit margin is 17.41%. Dr Pepper Snapple Group (DPS, Financial), whose brands include Dr Pepper, Canada Dry and 7Up, has a margin of 11.67%.

Does the company have a stable margin or even increasing margin?

Looking at the past 10 years, PepsiCo’s margin has not had significant fluctuations, but margins have been in decline since 2009.

In the 2013 annual report, the company reported that commodity inflation, mostly in Europe, Latin America, and AMEA region had reduced operating profit growth by 2 percentage points.

Is the growth speeding up? Is the earnings growth to date consistent?

GuruFocus rates PepsiCo’s business predictability as a perfect 5-stars due to its consistent revenue growth. Over the past 10 years, the net annual compound growth rate was 9%.

Certain segments have seen notable growth, particularly in emerging markets. PepsiCo saw 10% organic growth in developing markets, with countries including China, Pakistan, Brazil and Turkey.

EPS without non-recurring items was $4.32 in FY 2013 and has increased 2.76% over the past five years.

03May20171227251493832445.png

How did the company’s business fare during previous recessions?

During the Great Recession from 2007 to 2009, PepsiCo still saw increases in revenue per share each year. EPS without non-recurring items had a slight decrease from 2007 to 2008, but growth rebounded in 2009 to $3.77.

The company’s book value per share took a larger hit in 2008, decreasing to $7.77 from $10.68 the year before.

Overall, PepsiCo fared well during the recession. The segment that took the largest hit was PepsiCo Americas Beverages, whose revenue declined by 1% and operating profit declined by 7%, according to the 2008 annual report.

PepsiCo International’s brand portfolio managed to expand that year. It acquired beverage brands in Russia and the U.K., and introduced new snack flavors in India and China. These helped international revenues grow by 19% and operating profit to grow 16%.

The company’s resilience is due to the fact that it sells consumer staple goods who demand is relatively unaffected during times of economic uncertainty.

How did the company’s stock price fare during the previous recessions?

PepsiCo’s stock price remained stable throughout the Great Recession and even saw a slight uptick in 2008.

03May20171227251493832445.PNG

Is the balance sheet strong?

The company’s total current assets as of FY 2013 was more than $22 billion, while total current liabilities for the year was $17.8 billion. This gives a current ratio of 1.16, meaning PepsiCo is able to cover these liabilities with cash and other assets. A company should have a current ratio of 1 at the very least, so PepsiCo should take care to avoid adding to their liabilities.

The cash-to-debt ratio is 0.39 — a precarious position that shows PepsiCo cannot pay off its debt with cash on hand.

The debt-to-equity ratio at the end of the third quarter was 1.42. This figure has been increasing since 2010, though it dropped slightly from FY 2012 to FY 2013. A high debt-to-equity ratio can mean that a company is financing its growth with debt.

03May20171227251493832445.png

All in all, PepsiCo’s balance sheet needs work, and the company should address its debt levels.

Is the product that’s supposed to enrich the company is a major part of the company’s business?

The company’s main segments, PepsiCo Americas Foods and PepsiCo Americas Beverages, do indeed contribute a major part in revenue and profit. In 2013, the Americas Foods division comprised 37% of net revenue and 52% of operating profit, while the Americas Beverages division contributed 32% to net revenue and 26% to operating profit.

Is the company doing diworseifications that may reduce earnings in the future?

The root of the company dates back to 1898 when Caleb Bradham created Pepsi-Cola for his pharmacy customers. Since then, PepsiCo acquired Frito Lay and Quaker Foods to expand into the food and snack industry.

Half of PepsiCo’s business comes from the food segment, compared to Coca-Cola and Dr Pepper Snapple Group, which focus solely on beverages. This has helped to shield PepsiCo from the decline in demand in the carbonated soft drinks market, though some have argued the businesses should be separated.

Activist investor Nelson Peltz of Trian Partners, a major PepsiCo shareholder, urged the company to split the snack and beverage business in February. PepsiCo responded that it would retain both segments in one company.

One reason is that many of PepsiCo’s products are complimentary. For example, the company successfully marketed the pairing of Pepsi and Doritos in Hispanic markets.

PepsiCo has managed to build a well-diversified brand portfolio, while still keeping in line with the core snack and convenience foods theme.

Is the stock selling at a P/E ratio at or near growth rate?

PepsiCo’s current P/E ratio is 20.7, which is near its median point over the past 13 years at 19.12. The PEG ratio is 3.98, while the five-year average EBITDA growth rate is 5.2%, suggesting the company may be undervalued.

Is the P/E ratio high or low relative to historical value? The lower, the better.

The P/E ratio is currently near the median of the company’s 10-year range, with a low of 14.64 and a high of 27.08.

P/E ratio relative to similar companies? The lower, the better.

PepsiCo’s P/E ratio is lower than its main competitor Coca-Cola’s at 23.1. However, Dr Pepper Snapple Group has the lowest P/E at 19.7.

What is the percentage of institutional ownership? The lower, the better.

Institutional ownership was 75% at the end of the third quarter. This can be compared to Coca-Cola’s institutional ownership of 66%, and Dr Pepper Snapple Group at a much higher 97%.

Are insiders buying?

Insiders are not buying back PepsiCo’s stock. According to GuruFocus’ data, the last recorded insider buy was in 2007.

Is the company buying back shares?

In the company’s third-quarter earnings release, PepsiCo said it expects to repurchase $5 billion in shares by the end of 2014. The repurchase is part of a larger plan to return money to shareholders along with $3.7 billion in dividends.

Is the company's long term growth rate slowing down?

Over the past five years, PepsiCo’s annual revenue growth rate has been 10.8%, compared to 11.7% over the past 10 years. Therefore, the growth rate has been fairly steady over the long term. This is also reflected in the annual EBITDA and Book Value growth rates shown below.

03May20171227251493832445.PNG

PepsiCo's final score using this checklist is 3.8/5.

We’re celebrating GuruFocus’ 10th anniversary! Try the Premium Membership free for 7 days.