(Published Feb. 8 by Bob Ciura)
Consumer goods giant PepsiCo Inc. (PEP, Financial) has one of the longest histories of increasing dividends in the S&P 500.
The company has raised its dividend for 44 consecutive years. It is a Dividend Aristocrat, companies that have raised their dividends for at least 25 consecutive years.
You can see the entire list of Dividend Aristocrats here.
PepsiCo performed well in 2016. It was another slow but steady year for the company. Currently, the company is being challenged by the strong U.S. dollar and falling soda consumption.
It is investing in new products, however, and its sales are growing at a high rate in the emerging markets. This should provide the company with more than enough earnings growth to justify a solid dividend increase for 2017.
We will discuss PepsiCo’s financial performance and how much it will likely raise the dividend by this year.
Business overview
PepsiCo is a diversified food and beverage Goliath. It has 22 individual brands that each collect at least $1 billion in annual revenue.
These brands include Pepsi, Diet Pepsi, Mountain Dew, Cheetos, Doritos, Tostitos, Aquafina and many more.
Source: Investor Relations
Among product categories, PepsiCo’s annual sales are almost evenly balanced between food and beverages.
Source: 2016 Consumer Analyst Group of New York Conference, page 9
Its strong brands and growth in the emerging markets have provided steady growth throughout 2016. Over the first nine months of 2016, total revenue declined 2.7% from the same period in 2015.
The decline was due entirely to currency however. Excluding foreign exchange, organic revenue increased 3.7% in the nine-month period.
In addition to organic revenue growth, cost cuts and share repurchases resulted in 7% constant-currency EPS growth over the first three quarters of 2016.
Growth prospects
The most compelling growth catalyst for PepsiCo moving forward is growth in the international markets, particularly the emerging markets.
Emerging markets like China, India, Russia and Latin America have large populations and are seeing higher economic growth than the U.S.
This is resulting in rising standards of living and expanding middle classes. PepsiCo is enjoying strong growth in these regions of the world.
For example, PepsiCo’s organic revenue increased 9% in Latin America through the first nine months of 2016. Organic revenue increased 5% in Asia, the Middle East and Africa in the same time.
Nearly one-third of PepsiCo’s annual revenue now comes from emerging markets.
Source: 2016 Consumer Analyst Group of New York Conference, page 10
Another growth catalyst for PepsiCo is new products. The company has invested significantly to respond to changing consumer preferences.
Soda consumption has declined in the U.S. for the past decade. In turn, PepsiCo has built a separate brand portfolio called “Good-For-You” to appeal to health-conscious consumers.
PepsiCo now has many brands outside soda and salty snacks, including bottled water, juices, teas and healthy snacks like Sabra hummus.
Competitive advantages & recession performance
The first competitive advantage for PepsiCo is brand strength.
Every year, Forbes publishes a list of the world’s most valuable brands. In 2016, PepsiCo actually made the list twice: Pepsi takes the number 29 most valuable brand spot, while Frito-Lay is the 40th most valuable brand in the world.
PepsiCo’s huge portfolio of billion-dollar brands provides the company with a defensive quality that income investors should appreciate.
The company has the ability to remain profitable each year, even when the economy takes a nosedive. PepsiCo’s EPS even grew during the 2008 to 2009 Great Recession:
- 2007 EPS of $3.34
- 2008 EPS of $3.21
- 2009 EPS of $3.77
- 2010 EPS of $3.91
The second competitive advantage for PepsiCo is scale. PepsiCo is a global company with deep pockets. It has a market capitalization of $150 billion.
This provides PepsiCo with the financial flexibility to invest billions each year in advertising and marketing, which helps maintain its brand image with consumers.
Source: 2016 Consumer Analyst Group of New York Conference, page 48
PepsiCo also invests in research and development to fuel product innovation. PepsiCo’s R&D expense rose 44% from 2011 to 2015 to help fuel growth.
Additionally, PepsiCo’s global scale allows the company to cut costs, which boosts profitability. PepsiCo utilizes a process it calls a "closed-loop process," which helps keep a lid on costs.
Source: 2016 Consumer Analyst Group of New York Conference, page 32
Thanks to its cost-cutting program, PepsiCo realized $1 billion of cost savings in 2015. Its focus on efficiency drove a 320 basis-point expansion in return on invested capital from 2013 to 2015.
Dividend analysis
PepsiCo currently pays an annual dividend of $3.01 per share. Based on its present share price, the stock has a 2.9% dividend yield.
On the surface, PepsiCo does not look like it can afford a strong dividend increase. Its GAAP EPS were $3.37 over the trailing 12 months.
Based on GAAP EPS, PepsiCo carries a nearly 90% payout ratio.
That being said, the company’s GAAP results over the past year have been weighed down by currency fluctuations. The strong U.S. dollar has negatively impacted multinational companies like PepsiCo.
Excluding currency fluctuations and other nonrecurring items, PepsiCo generated organic EPS of $4.71 in the past four quarters.
On this basis, PepsiCo has a much more modest payout ratio of 64%. The company distributes less than two-thirds of its core EPS.
This should leave enough room for a mid- to high-single-digit dividend increase on a percentage basis. For example, a 6% to 8% dividend increase would still result in a payout ratio less than 70%.
Final thoughts
PepsiCo has a rich product portfolio, a global reach and plenty of future growth catalysts. It has many high-quality brands that provide the company with steady profits and reliable growth each year.
These qualities have allowed PepsiCo to raise its dividend for more than four decades. It is almost assured the company will continue its streak this year, raising its dividend for the 45th year in a row in 2017.
Last year, PepsiCo announced its dividend increase in mid-February, which means the company could possibly announce its dividend in a matter of days.
Investors should reasonably expect PepsiCo to increase its dividend by 6% to 8% in 2017.
Disclosure: I am long PEP.
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