PepsiCo (PEP) is one of the most popular stocks among dividend investors worldwide. The American multinational food and beverage corporation is well known for stable growth and solid performance. Although the beverage industry is currently facing headwinds, PepsiCo is still a worthwhile investment.
There are many shareholders waiting for a Dorito spinoff. Until that happens the below is the key Pepsi attributes. This is a blue chip company with a rising interest rate, a constant influx of new products, and a head-to-head battle with Coca-Cola $KO.
Market outlook: Beverage industry is in a downturn; players focus on emerging markets and product innovation
The market for carbonated soft drinks has been under pressure recently. Sales are decreasing, primarily in developed economies. One reason is lower consumer spending in the US and Europe. That could change as the US economy is showing signs of recovery. However, this trend could also lead to a stronger US Dollar, which harms multinational corporations like PepsiCo. Furthermore, the Federal Reserve Bank (Fed) will probably increase interest rates this year, which could appreciate the dollar even more.
Another reason is that consumers shift towards healthier products. Therefore, PepsiCo invests heavily in product innovations. The company will offer new drinks based on more natural and healthier ingredients compared to previous products. PepsiCo announced for example an aspartame free Diet Pepsi and strives to make its snack products more appealing to health-focused customers.
In general, PepsiCo is focusing more on emerging markets and developed a clever brand building and distribution strategy. A great example is PepsiCo’s new alliance with Starbucks. Both companies entered a partnership to sell coffee and energy drinks in Latin America. Moreover, on the contrary to major competitor Coca-Cola, the snacks division accounts for more than 50% of PepsiCo’s valuation. That provides an advantage considering the drop in sales of carbonated soft drinks.
Organic revenue is growing but profit suffers from currency effects
PepsiCo generated $15.9 billion in revenue in the second quarter (Q2) of 2015. Compared to its major competitor Coca-Cola, PepsiCo is performing well. Organic revenue grew by 5.1% (Coca-Cola: 5%) and core constant currency earnings per share increased by 11% (Coca-Cola: 13%). PepsiCo’s earnings growth has been steady over the last years, including the years of the Great Depression.
Adjusted earnings per share came in at $1.32 in Q2 2015, which was slightly higher than estimates predicted. As the beverage market is in a downturn, most of the additional revenue came from the snacks business and intensified operations in emerging markets. PepsiCo’s global snacks were up 8% while the beverage business grew by only 2%.
The strength of the US dollar weighs heavily on PepsiCo’s profits, because the company is currently operating in more than 200 countries. Obviously, the dollar rally will not continue forever, so long-term investors should look at currency-adjusted values. In Q2, PepsiCo’s core constant currency operating profit grew by 8%. However, short-term investors should look at the non-adjusted values, because profits are reported in US dollar and that will be a problem during the next months, maybe even during the next years.
PepsiCo offers a strong 2.9% dividend yield, although only 50% of the free cash flow is used to pay out dividends
PepsiCo is considered one of the most valuable dividend stocks worldwide. It has a strong 2.9% dividend yield and an impressive track record of more than two decades of dividend growth. The company never missed or lowered its dividends, which it pays in quarterly installments. In the past decade, the smallest dividend increase was 5%, which is still quite high. Not many companies can make that claim.
A steady cash flow is the most important indicator for the ability to maintain a strong dividend record. PepsiCo’s cash flow clearly supports its dividend policy. The company is only using half of its free cash flow to pay out dividends. Therefore, PepsiCo will also be able to maintain its high dividends, if the cash flow drops. Furthermore, it means that there is more than enough room to continue to grow dividends over the coming years.
The remaining free cash flow is used to buy back shares. The company has done that over the last years and the management has already announced that they will continue to buy back shares worth several billion US dollars each year. That reduces the ability to pay dividends somewhat, but the door is still wide open for further growth.
Price-to-free cash flow ratio indicates moderate undervaluation
In most cases, investors look at the correlation between price and earnings or between price and net income in order to estimate whether or not a company is undervalued. PepsiCo is currently trading at a trailing PE ratio of 22.5x (Coca-Cola: 25.8x) and a forward PE ratio of 19.8x (Coca-Cola: 19.0x).
However, in case of dividend stocks, it makes more sense to look at the correlation between price and cash flow, because dividends are a real cash disbursement, while earnings and net income are non-cash accounting metrics.
PepsiCo’s stock price is highly correlated to their cash flow. The price-to-free cash flow ratio based on Q2 figures is 18.7x. The median during the past 13 years was 21.3x, ranging from 16.6x to 32.9x. Looking at this ratio, the company seems to be moderately undervalued.
PepsiCo won’t face liquidity problems any time soon, but interest expenses weigh on profit margin
PepsiCo has about $23 billion of long-term debt and short-term obligations of $8.4 billion. Most of the long-term debt will not mature before 2020 and the company has sufficient credit facilities (more than $7.5 billion, which can be extended to $9 billion) to cover its short-term debt. Therefore, PepsiCo will not face liquidity problems any time soon. URL?
However, their current interest coverage ratio is 10.4x, which is slightly lower than the ratio of major competitors (Coca-Cola 12.3x). Hence, the company earns lower profits relative to their interest expenses than its competitors. That squeezes PepsiCo’s profit margin. However, the company makes an effort to save costs and diversify its product line in order to increase profits.
Conclusion: PepsiCo is a safe and stable investment for retirement investors who are interested in dividends and capital gains
Listed among the best SAFE dividend stocks, PepsiCo is a great company for dividend investors. Growth investors will find better stocks, but PepsiCo offers potential for capital gains as well.
Looking at the fundamentals, PepsiCo appears to be a stable company. Steady earnings growth in a down-turning market demonstrates the management’s ability to address issues through strategic planning.
Currency effects are weighing on profits, short-term investors should pay attention to this issue. Liquidity risks are low and cash flow data shows that dividends are relatively safe and will most likely continue to grow. The stock is a buy at 22.5x P/E multiple (18.7x price-to-free cash flow multiple) and 2.9% dividend yield. Investors who buy for income and retirement purposes should take a look at PepsiCo.