PepsiCo Inc. (PEP, Financial) experienced a challenging 2023 as its share price declined nearly 8% over the past 12 months. This performance fell short of the S&P 500's 24% return over the same period. The lackluster progress of the shares could be attributed to the market concerns about GLP-1 and Ozempic weight loss drugs. These drugs might lead consumers to reduce their snack consumption, impacting PepsiCo's sales rather than reflecting the company's fundamentals.
I believe PepsiCo's current share price is undervalued to its business potential.
Global dominance in convenient foods and beverages
PepsiCo is a leading corporation in the fast-moving consumer goods industry, manufacturing and distributing a wide range of convenient food and beverages. It serves consumers in over 200 countries and territories, boasting a portfolio of renowned brands, including Pepsi, Doritos, Lay's, Mountain Dew and SodaStream. The company is structured into eight operating segments, including Frito-Lay North America (FLNA), which focuses on branded convenience businesses in the U.S. and Canada, and Quaker Foods North America (QFNA), known for its branded cereals, rice, pasta and other food products. The other segments are PepsiCo Beverages North America (PBNA), Latin America (LatAm), Europe, Africa, Middle East and South Asia (AMESA) and Asia Pacific, Australia, New Zealand and China (APAC).
In 2022, the most significant revenue contributors were PBNA, generating $26.2 billion, which accounted for 30.3% of the total revenue, and FLNA, with $23.3 billion in revenue, representing 27% of the company's total sales. This segment breakdown highlights the diverse and global nature of PepsiCo's operations, underlining its status as a dominant player in the convenience food and beverage market.
Mitigating health trends with strategic portfolio shifts
Recenly, weight-loss medications like Ozempic and Wegovy have gained significant popularity. They function by delaying the transfer of food from the stomach to the small intestine, leading to a quicker and longer-lasting sensation of fullness in consumers. As a result, consumers would purchase less salty and fatty snacks. This shift in consumer behavior could potentially affect snack-producing companies, including PepsiCo. Nonetheless, the accessibility of these drugs to the broader population is restricted by their high cost, with Wegovy's annual price tag exceeding $16,000.
In a recent earnings call, PepsiCo CEO Ramon Laguarta noted the impact of these drugs on the company's business has been minimal so far. Moreover, it has been proactively diversifying its offerings into healthier food and beverage options, including zero-sugar Pepsi, Gatorade and Cytosport's protein bars. The company has set ambitious targets for its product portfolio: aiming for at least two-thirds of its beverage volume to contain 100 or fewer calories and 75% of its global foods portfolio volume to contain less than 1.3 milligrams of sodium per calorie and less than 1.1 grams of saturated fat per calorie. This strategic shift toward healthier options positions PepsiCo well in a global market that is increasingly health-conscious.
In the third quarter, PepsiCo reported a 7% increase in revenue, reaching $23.45 billion, while its operating margin saw notable growth of 20%, surpassing $4 billion. This improvement in operating margin, rising from 15.3% in the same quarter of the previous year to 17.1% this year, can be attributed to productivity savings and mark-to-market gains on commodity derivatives. Indeed, the company has kept delivering growth and improvement in profitability.
Leverages debt and buybacks to enhance shareholder value
At first glance, investors might express concerns regarding PepsiCo's substantial debt obligations recorded on the balance sheet. In the third quarter, the company's shareholders' equity stood at $18.8 billion, in contrast to a considerably higher long-term debt of nearly $35.84 billion and a short-term debt close to $9 billion. Consequently, the debt-to-equity ratio approached 2.4. However, it is important to note these long-term debt obligations, which feature low interest rates, have been extended to 2060.
Between 2023 and 2027, PepsiCo is scheduled to make principal payments ranging from $2.4 billion to $3.2 billion annually. Given the company's track record of generating an average annual operating cash flow exceeding $10 billion over the past decade, it is well-positioned to manage both interest and principal payments comfortably.
Source: PepsiCo's 10-K
Additionally, the low shareholders' equity is primarily due to the company's extensive share repurchase program, which amounted to $40 billion as of September 2023. PepsiCo has consistently repurchased shares every year, reducing its share count from 1.56 billion in 2023 to approximately 1.39 billion at the time of writing.
Consistent dividend growth
Income investors are particularly fond of PepsiCo for its consistent dividend payments. Over the past decade, the company has increased its dividend per share from $2.24 in 2013 to $4.52 in 2022, achieving an annual compounded growth rate of approximately 7.3%. During this period, the cash flow from operations has more than sufficed to cover the dividend payments, representing 35% to 55% of the operating cash flow. Consequently, PepsiCo's robust operating cash flow is more than adequate to sustain annual dividend distributions to its shareholders. With the upcoming annual dividend per share of $5.06 in 2023, the annual dividend yield reaches 3%.
By 2024, PepsiCo is projected to generate approximately $96.5 billion in revenue and earnings per share of $8.16. Using its five-year average earnings multiple of 25.30, the company's share value is estimated at around $204, 21.5% higher than its current trading price.
The bottom line
Despite the challenges faced in 2023, PepsiCo's fundamental strength and strategic initiatives position it as a resilient and promising investment. The company's diverse global operations, proactive shift toward healthier products and consistent financial performance underline its capacity to adapt and thrive in a dynamic market. With a robust operating cash flow supporting its dividend payments and an estimated share value significantly higher than its current trading price, PepsiCo demonstrates potential for growth and value creation for its shareholders. Investors looking for long-term stability and growth in the fast-moving consumer goods sector would do well to consider PepsiCo as a key component of their investment portfolio.
