PepsiCo (PEP, Financial) is among the world’s best blue-chip dividend stocks. PepsiCo has taken many twists and turns over its many decades of existence. The current entity was created through the merger of Pepsi-Cola and Frito-Lay.
Pepsi-Cola was established in the late 1890s by Caleb Bradham, a North Carolina pharmacist.
Frito-Lay Inc. was formed in 1961 when the Frito Company, founded by Elmer Doolin in 1932, and the H. W. Lay Company, founded by Herman W. Lay in 1932, combined.
PepsiCo is a Dividend Aristocrat. The Dividend Aristocrats are a select group of 50 stocks that have at least 25 consecutive years of dividend increases. You can see the entire list of Dividend Aristocrats here.
Earlier this year, PepsiCo increased its dividend by 7%. It marked the 44th consecutive year that PepsiCo increased its dividend.
Business overview
Today, PepsiCo is a global food and beverage giant.
PepsiCo’s business is nearly split between its food and beverage segments. It is also nearly split geographically, between the U.S. and the rest of the world.
Source: 2015 Annual Report, page 12
PepsiCo’s international business is leading the company’s growth. Last year, organic revenue increased 8% in the international markets, along with 6% growth in constant currency operating profit.
This has proven to be the case so far in 2016. For example, over the first three quarters of the year, organic revenue increased 9% in Latin America.
PepsiCo’s revenue and profit accounting for each business segment are as follows:
Source: 2015 Annual Report, page 12
The two businesses complement each other well. The Pepsi brand, as well as PepsiCo’s other soda products, is struggling right now due to the drop in soda consumption.
Consumers, particularly in the U.S., are adopting a hasher view of soda. This is why soda sales have fallen for 11 years in a row, according to industry research firm Beverage Digest.
Fortunately, PepsiCo’s snacks business is helping to offset weakness in soda.
Growth prospects
In 2013, PepsiCo was urged by one of its largest institutional shareholders to break itself up. Trian Fund Management, a money management firm led by noted activist investor Nelson Peltz, sent a letter to PepsiCo asking management to consider a spinoff.
The rationale was that, according to Trian, PepsiCo could create value for shareholders by spinning off its food and beverage segments. In theory, both companies trading publicly as independent stocks would receive a higher cumulative valuation than the existing company.
However, PepsiCo management did not bite. Instead, CEO Indra Nooyi insisted the company was ‘better together.’ The company insisted that holding Pepsi and Frito-Lay under one roof provided significant efficiencies in distribution and supply chain.
Trian backed off two years later. Judging by the company’s performance, it is clear that PepsiCo management had the right strategy.
Source: Barclays 2016 Back-to-School Consumer Conference, page 3
PepsiCo has consistently maintained that having both segments gives the company valuable leverage with retailers for optimal shelf space. It also provides more room for productivity gains.
Improving efficiency was a key reason for PepsiCo’s 10% earnings per share growth last year, excluding foreign exchange impacts.
Keeping PepsiCo together allows the company to more clearly identify, and more effectively pursue, the opportunities for cost savings across the enterprise.
Source: 2016 Consumer Analyst Group of New York Conference, page 31
PepsiCo has realized savings across its supply chain and distribution network. The company delivered more than $1 billion of cost savings last year alone.
This is what drove a 210-basis point improvement in return on invested capital last year when compared with 2014.
Competitive advantages & recession performance
PepsiCo has two major competitive advantages. These are its global scale and its valuable brand. The competitive advantages come 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.
According to Forbes, Pepsi is the 29th most valuable brand in the world. Frito-Lay takes the 40th spot.
In all, PepsiCo has 22 individual brands that each collect at least $1 billion in annual revenue. Its portfolio of well-known brands provide a floor underneath PepsiCo’s earnings per share.
One of the best reasons for long-term investors to own PepsiCo stock is because of its resiliency during economic downturns. PepsiCo has a highly defensive business. Food and beverages always retain a certain level of demand. This is why the company held up so well, even during the Great Recession.
PepsiCo’s EPS throughout the Great Recession of 2007 to 2009 are listed below:
- 2007 EPS of $3.34
- 2008 EPS of $3.21
- 2009 EPS of $3.77
- 2010 EPS of $3.91
As you can see, PepsiCo’s EPSÂ declined only modestly during the financial crisis and quickly rebounded once the recession was over.
In fact, PepsiCo’s EPS reached a new high in 2009, when many other companies were simply trying to stay afloat.
Valuation & expected total return
PepsiCo stock trades for a price-earnings ratio of 22. This is below the S&P 500 average. The S&P 500 Index trades for a price-earnings ratio of 25.
Meanwhile, PespiCo stock is valued at a slight premium to its own historical average. Since 2000, it has held an average price-earnings ratio of 20.
PepsiCo’s valuation is a mixed bag. The stock appears to be fairly valued.
As such, its future returns will likely be comprised of EPS growth and dividends. Earnings per share growth could be fueled by the following factors:
- 3% to 5% organic revenue growth
- 1% growth from acquisitions
- 1% margin expansion
- 2% share repurchases
In addition to its 3% current dividend yield, investors buying now could generate 10% to 12% annualized returns moving forward.
Final thoughts
PepsiCo is a highly profitable company. It has multiple strong brands and benefits from its massive scale. Going forward, PepsiCo should continue to generate steady growth. This will be achieved through new products, growth in the international markets and cost cuts.
In turn, PepsiCo should have little trouble increasing its dividend moving forward. Management is committed to rewarding shareholders with regular dividend growth.
PepsiCo stock has a solid 3% dividend yield and the prospect of solid growth rates of EPS and dividends over the long term. As a result, PepsiCo could be viewed as a core holding for dividend growth investors.
The company has an above-average rank using The 8 Rules of Dividend Investing. With that being said, PepsiCo is not my top choice (at current prices) for dividend growth investors looking for exposure to the consumer staples sector. The company is a hold at current prices.
Disclosure: I am long PEP.
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