There seems to have been a considerable buzz around these two companies in value investing circles in the last few weeks. Both companies have big-name supporters (in the case of Tesco, the biggest!). Let's have a closer look...
A couple of Reported EPS and dividend graphs.
First, Tesco (TESO).
And then Pepsi (PEP, Financial).
Over the long term (10 or more years), both companies have a picture of steadily increasing earnings per share and dividends.
In fact the EPS growth rate charted in the data above is 11.49% and 9.04% respectively. Neither result was achieved in a “hot” industry. If I was looking for a sexy new investment theme it is unlikely that supermarkets and cola would feature highly — they’ve both been around for decades.
2. Which company uses its capital more efficiently?
During this extended period the total dividend payout percentage and the average return on equity (simple) is shown below.
Both companies' return on equity levels are reasonable returns. However, for various reasons simple ROE is subject to distortions and should be thought of only as an indicative ratio. According to Warren Buffet a better measure of business quality (and an indication of the goodwill a company is likely to deserve) is the return on unleveraged NTA.
From the last completed fiscal year:
Its quite clear that Pepsi makes significantly more money from every dollar of its tangible asset base than Tesco. This is where the business model of buying commodities and selling brands has a big advantage over having to own expensive real estate, trucks, inventory and the like.
Profit margin comparisons are most useful for similar companies in the same industry but for the record Pepsi enjoys a significantly higher margin on sales (I use EBITA margin). Using the most recent fiscal year's results above it comes in at 14.8% vs. 6.3% at Tesco.
Looking at it in this way, Pepsi is by far the superior business and if Mr Market ever gives you the option of buying Pepsi and Tesco at tangible asset value you would be significantly better off buying Pepsi. I wouldn’t hold your breath, however, as this particular offer is unlikely to ever occur!
3. D- D- D- Debt...
Debt is another financial piece in the puzzle. Both Pepsi and Tesco carry significant LT and ST debt. I like to think of this as, how many years of normalized after-tax profits would be required to extinguish all existing borrowing if the company decided to do so?
Debt levels are similar for both companies but in my book these are both uncomfortably high. It should be noted that Tesco has a stated goal to bring its debt levels down.
So what?
All of this is interesting of course but it really only helps to define the comparison a little more clearly. Both companies have significant debt and a similar (attractive) long term growth rate in EPS and dividends. The key difference so far is that Pepsi has far lower capital requirements.
As is repeated ad nauseum in financial literature, past performance does not guarantee future returns.
The next 10 years of EPS numbers will be determined by 1. The nature and durability of the ongoing business 2. Management's ability to efficiently maintain earnings on current equity and 3. Management's ability to put retained equity to work in new opportunities at decent rates of return (the “what will they do with the money?" factor of a certain Mr Buffet).
This is largely subjective and more difficult, but it will be the subject of Part 2.
A couple of Reported EPS and dividend graphs.
First, Tesco (TESO).
And then Pepsi (PEP, Financial).
Over the long term (10 or more years), both companies have a picture of steadily increasing earnings per share and dividends.
In fact the EPS growth rate charted in the data above is 11.49% and 9.04% respectively. Neither result was achieved in a “hot” industry. If I was looking for a sexy new investment theme it is unlikely that supermarkets and cola would feature highly — they’ve both been around for decades.
2. Which company uses its capital more efficiently?
During this extended period the total dividend payout percentage and the average return on equity (simple) is shown below.
Both companies' return on equity levels are reasonable returns. However, for various reasons simple ROE is subject to distortions and should be thought of only as an indicative ratio. According to Warren Buffet a better measure of business quality (and an indication of the goodwill a company is likely to deserve) is the return on unleveraged NTA.
From the last completed fiscal year:
Its quite clear that Pepsi makes significantly more money from every dollar of its tangible asset base than Tesco. This is where the business model of buying commodities and selling brands has a big advantage over having to own expensive real estate, trucks, inventory and the like.
Profit margin comparisons are most useful for similar companies in the same industry but for the record Pepsi enjoys a significantly higher margin on sales (I use EBITA margin). Using the most recent fiscal year's results above it comes in at 14.8% vs. 6.3% at Tesco.
Looking at it in this way, Pepsi is by far the superior business and if Mr Market ever gives you the option of buying Pepsi and Tesco at tangible asset value you would be significantly better off buying Pepsi. I wouldn’t hold your breath, however, as this particular offer is unlikely to ever occur!
3. D- D- D- Debt...
Debt is another financial piece in the puzzle. Both Pepsi and Tesco carry significant LT and ST debt. I like to think of this as, how many years of normalized after-tax profits would be required to extinguish all existing borrowing if the company decided to do so?
Debt levels are similar for both companies but in my book these are both uncomfortably high. It should be noted that Tesco has a stated goal to bring its debt levels down.
So what?
All of this is interesting of course but it really only helps to define the comparison a little more clearly. Both companies have significant debt and a similar (attractive) long term growth rate in EPS and dividends. The key difference so far is that Pepsi has far lower capital requirements.
As is repeated ad nauseum in financial literature, past performance does not guarantee future returns.
The next 10 years of EPS numbers will be determined by 1. The nature and durability of the ongoing business 2. Management's ability to efficiently maintain earnings on current equity and 3. Management's ability to put retained equity to work in new opportunities at decent rates of return (the “what will they do with the money?" factor of a certain Mr Buffet).
This is largely subjective and more difficult, but it will be the subject of Part 2.
