As shown in the image below, Pepsi (PEP, Financial) shares have been resilient over time despite the occurrence of certain black swan events, such as the tech bubble in the 2000s and the Great Recession. Including its 44th consecutive year of dividend this year, Pepsi has given a total return of 6.86% for the past 10 years. In comparison, the broader S&P 500 has given 7.22%. Year-to-date, Pepsi has outperformed the market with 7.57% compared with a 6.34% return for the S&P 500.
(Pepsi Market Price, Google Finance)
Valuations
According to GuruFocus data, Pepsi’s shares had a trailing 12-month price-to-earnings ratio of 29.7 times (industry median of 21.6), price-to-book value of 12.4 times (industry median of 2.7) and price-to-sales ratio of 2.49 times (industry median of 1.38). The snack company also has a trailing 12-month dividend yield of 2.77% with an 81% payout ratio. The company is also an active buyer of its shares with a 2.1% buyback ratio.
These multiples definitely are not attractive at all compared to Pepsi’s peers. Also, it is worth taking note that Pepsi’s shares were trading between 16 and 17 times earnings during the recent recession. It’s therefore prudent for prospective investors to check Pepsi’s ongoing snack business and determine whether its shares would be a good investment given any market share price collapse.
Recommendations
Despite Pepsi’s premium over its peers and the broader S&P 500 index, several analysts indicated that the company’s shares are still a buy.
According to Financial Visualizations, Credit Suisse (CS, Financial), UBS (UBS, Financial) and Deutsche Bank (DB, Financial) had all initiated and reiterated that Pepsi’s shares are a buy. Averaging their target range and prices for the company gave me a value of $116 a share, a 10.5% capital return from Pepsi’s recent share price.
Issues (health and market trends)
Pepsi recently settled a case that found its sodas contained an exceeded amount of caramel coloring. According to Natural News, the caramel coloring compound called 4-Mel, which is short for 4-Methylimidazole, is a carcinogen. The substance was found in Pepsi’s products by an environmental group called Center for Environmental Health.
In the settlement, Pepsi must require its providers of caramel coloring to ensure that levels of 4-MeI stay below 100 parts per billion in products shipped for sale within the United States.
Nonetheless, "no matter how much consumers drink they don't expect their beverages to have a potential carcinogen in them. And we don't think 4-MeI should be in foods at all. Our tests of Coke samples show that it is possible to get to much lower levels," toxicologist Dr. Urvashi Rangan said.
(Decline in Soda Consumption, New York Times)
On the other hand, there is an ongoing decline in soda consumption. Interestingly, Pepsi still thrived during the supposed difficult period and delivered a 10-year (FY 2006 to FY 2015) sales growth average of 6.8%. Pepsi’s close peer, Coca-Cola (KO, Financial), grew its sales by 6.7% in the same time frame. In FY 2015, Pepsi had 47% of its total sales from beverage.
(No to Soda Tax Demonstration, Wall Street Journal)
In addition, there is an ongoing dispute in Philadelphia regarding the special tax on sweetened drinks. In June, the city council approved a levy of 1.5 cents per ounce on nonalcoholic beverages with added sweeteners ranging from soda to sports drinks and energy drinks. The group of beverage companies, such as Coca-Cola, Pepsi, and Dr. Pepper Snapple Group (DPS), filed a lawsuit and stated that the levy would raise its products’ prices by 31% in Philadelphia alone, that would eventually lead to fewer sales and a revenue loss between $2.7 million to $7.8 million.
(Pepsi, Quarterly Filing)
Pepsi
Pepsi is a 97-year-old company and a leading global food and beverage company. The snack business company has several brands under its business: FritoLay, Gatorade, Pepsi-Cola, Quaker and Tropicana.
In its recent annual filing, the company had six reportable segments: 1) Frito-Lay North America (FLNA); 2) Quaker Foods North America (QFNA); 3) North America Beverages (NAB); 4) Latin America; 5) Europe Sub-Saharan Africa (ESSA), and 6) Asia, Middle East and North Africa (AMENA).
Frito-Lay North America (FLNA)
According to Pepsi, the FLNA segment (either independently or in conjunction with third parties) makes, markets, distributes and sells branded snack foods. These foods include Lay’s potato chips, Doritos tortilla chips, Cheetos cheese-flavored snacks, Tostitos tortilla chips, branded dips, Fritos corn chips, Ruffles potato chips and Santitas tortilla chips. Also included are the Sabra refrigerated dips and spreads, with FLNA’s joint venture with Strauss Group.
FLNA contributed almost a quarter, or $14.8 billion, of Pepsi’s total annual sales in FY 2015. FLNA also had an operating margin of 29% in the same year. The segment had a three-year (FY 2012 to FY 2015) sales growth average of 2.9%.
Quaker Foods North America (QFNA)
The QFNA segment makes, markets, distributes and sells cereals, rice, pasta, dairy and other branded products. QFNA’s products include Quaker oatmeal, Aunt Jemima mixes and syrups, Quaker Chewy granola bars, Cap’n Crunch cereal, Quaker grits, Life cereal, Rice-A-Roni side dishes, Quaker rice cakes, Quaker natural granola and Quaker oat squares.
QFNA contributed about 4%, or $2.5 billion, to Pepsi’s FY 2015 total sales. The segment had a 22% operating margin. QFNA had a three-year average decline of -1.2%.
North America Beverages (NAB)
The NAB segement makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Pepsi, Gatorade, Mountain Dew, Diet Pepsi, Aquafina, Diet Mountain Dew, Tropicana Pure Premium, Sierra Mist and Mug.
NAB also does business in tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, NAB manufactures and distributes certain brands licensed from Dr Pepper Snapple Group (DPSG), including Dr Pepper, Crush and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). NAB also sells concentrate and finished goods for its brands to authorized and independent bottlers.
NAB contributed 33%, or $20.6 billion, to Pepsi’s FY 2015 total sales. The segment also had an operating margin of 13.5% in the same time period with a two-year (FY 2014 to FY 2015) sales growth of 1.3%.
Latin America
Latin America includes all of Pepsi’s beverage, food and snack businesses in Latin America. The segment makes, markets, distributes and sells a number of snack food brands including Doritos, Cheetos, Marias Gamesa, Ruffles, Emperador, Saladitas, Sabritas, Lay’s, Rosquinhas Mabel and Tostitos, as well as many Quaker-branded cereals and snacks.
The Latin America segment also does business in beverage concentrates, fountain syrups and finished goods under various beverage brands including Pepsi, 7UP, Gatorade, Mirinda, Diet 7UP, Manzanita Sol and Diet Pepsi. Latin America also, has an international joint venture with Unilever (under the Lipton brand name).
Latin America contributed 13%, or $8.2 billion, in sales last year. Nonetheless, the segment reported at a loss of $206 million, after taking a $1.4 billion impairment of investments in Pepsi’s wholly-owned Venezuelan subsidiaries and beverage joint venture.
Europe Sub-Saharan Africa (ESSA)
ESSA includes all of Pepsi’s beverage, food and snack businesses in Europe and Sub-Saharan Africa.
ESSA also does business in beverage concentrates, fountain syrups and finished goods under various beverage brands including Pepsi, 7UP, Pepsi Max, Mirinda, Diet Pepsi and Tropicana.
ESSA also makes, markets and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). The segment also does business in a number of leading dairy products including Chudo, Agusha and Domik v Derevne.
ESSA contributed 17%, or $10.5 billion, in total Pepsi sales last year. The segment also had an operating margin of 10.3% and a two-year average decline of -12.3%.
Asia, Middle East and North Africa (AMENA)
AMENA includes all of Pepsi’s beverage, food and snack businesses in Asia, Middle East and North Africa. In addition to the possible long list that AMENA does business in the respective countries, the segment also licensed the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi).
AMENA contributed approximately 10%, or $6.4 billion, in total sales last year. The segment also delivered a 14.8% operating margin along with a two-year decline of -0.38%.
(Pepsi, Annual Filing)
Sales and profits
On July 7, Pepsi reported its second quarter and first half FY 2016 results. For the first half of FY 2016, the snack company reported a 3% sales decline to $27.3 billion and 8% decline to $2.9 billion. Despite the negative growth in both top and bottom lines, Pepsi’s shares were up 1.48% at market close.
“In what continues to be an incredibly volatile global macro environment, we are pleased with our results for the second quarter. While reported net revenue performance was negatively impacted by foreign exchange translation and the deconsolidation of our Venezuelan operations, we delivered balanced volume growth and positive price/mix driven by relentless execution of our commercial agenda and leading to solid organic revenue growth. At the same time, our focus on driving greater efficiency throughout our operations contributed significantly to attractive margin expansion while we continued to invest in our business.”
“Based on our year-to-date performance, we are raising our full-year core constant currency EPS growth objective.”
Pepsi Chairman and CEO Indra Nooyi.
(Pepsi, Annual Filing)
Cash, debt and book value
As of June 11, Pepsi had total cash of $13.4 billion. The company also had total debt of $35.6 billion with a debt-to-equity ratio of 2.88 times. Pepsi also had 36%, or $26.5 billion, of its assets in goodwill and intangibles.
Cash flow
(Pepsi Cash Flow, Quarterly Filing)
In 1H FY 2016, Pepsi grew its cash flow from operations by 5.8% to $2.9 billion despite weak profit growth. The snack and beverage company allocated $919 million in capital expenditures, leaving it with $2 billion in free cash flow. Pepsi also invested $808 million in short-term investments.
The company also took in $5.4 billion in debt, while also reducing it by $3.08 billion. Pepsi provided $3.4 billion in net shareholder return (2). For the past three years (FY 2013 to FY 2015), Pepsi allocated an average of 108% of its free cash flow for dividends and share repurchases.
Conclusion
Pepsi does seem to be a good pick during market correction. The company’s shares had performed well over time, mildly underperforming the broader S&P 500. Pepsi is also included in the Dividend Aristocrats, or companies that have raised dividends in the past 25 years.
Pepsi, with a market capitalization of $151.5 billion, demonstrated resiliency given the recent market blips and uncertainty. Despite several analysts’ buy recommendation, Pepsi’s current valuations are never to be considered fairly valued. An investor would also want to watch Pepsi’s balance sheet figures.
I figured that I should not be a willing buyer of Pepsi’s shares despite it falling 7.6%, or to $97 a share (3), from its current price. This puts me out as a prospective buyer of its shares from near to possibly long-term.
Nonetheless, I do not think Pepsi would struggle in the ongoing challenges in the soda industry. I see it emerging from it along with Coca-Cola.
In summary, I would label the company as a HOLD.
Notes
(1) The difference in the business description can be observed in page 4 of FY 2014 annual report and page 3 of 2015.
(2) Dividends plus share repurchases (both common and preferred)
(3) The $97 value was derived from five-year average earnings multiple and Pepsi’s forecasted FY 2016 core earnings per share.
Disclosure: I do not have shares in any of the companies mentioned in this article.
