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Perhaps you are ready to buy some PepsiCo stock, but you want to know more about Pepsi as a dividend aristocrat? Every investor needs to have rules to help them choose companies to perform due diligence. As an investor, I have a Dividend Growth Strategy with growing and sustainable dividends at its foundation.
Recently I have been focusing on quality companies like Unilever and Microsoft as these are a couple of my foundation stocks but PepsiCo is a company I have been considering adding to my portfolio.
In this article, I will answer questions on whether PepsiCo is a good dividend stock and whether its stock is a good investment.
Company Introduction
Pepsi is one of the leading dividend snack and beverage food companies in the world. This company was established during the merging of Frito-Lay and Pepsi-Cola. Pepsi-Cola was created in 1893, and Frito-Lay in 1961. PepsiCo has a diverse global product portfolio of more than 20 brands. They reside in the beverage and savory snacks categories. These products include Pepsi, Pepsi Max, Diet Pepsi, 7 Up, Tropicana, Mountain Dew, Diet Mountain Dew, Lipton, Miranda, Quaker, Sierra Mist, Ruffles, Gatorade, Aquafina, Tostitos, Brisk, Walkers, Starbucks RTD Beverages, Cheetos, Fritos, Doritos, and Lays.
When I was researching PepsiCo’s business priorities, I found that they are interested in growing their product revenue, leveraging their number one position in global savory snacks, and expanding their number 2 global position in beverages. They are also interested in reinforcing growth in developed markets and stimulating growth by investing in foreign markets. PepsiCo wants to accelerate investments in digitalization and technology, supply chain agility, and manufacturing capacity. They want to manage costs to achieve automation, increase asset utilization, and increase returns on investments. Their financial improvement goals are an expansion of operating margin, 4% or more organic revenue growth, and 7% or more constant currency earnings per share growth.
PepsiCo Growth
According to PepsiCo, their Net Revenue in its 2020 annual results increased by 4.8%. This rise was made possible by a solid and robust 4th quarter where the saw deals rise 8.8%. At the ending of 2020, the company posted net revenues of $70.37 billion. Its operating profit for 2020 was at $10.08 billion, a 2% decrease from the $10.29 billion figure of 2019. PepsiCo’s China, Asia Pacific, New Zealand, and Australia unit saw a 24% operating profit increase, partly accounted for by 18% net revenue growth.
PepsiCo’s South Asia, Africa, and the Middle East and South Asia unit saw an increase in net revenue, but operating profit decreased 11%, primarily due to an increase in operating cost.
https://www.buymeacoffee.com/dividendtalk
Quaker Foods North American unit reported a 23% growth in operating profit and 10% growth in net revenue. Its Frito-Lay North American division reported a 2% increase in operating profit, primarily made possible by growth in its productivity savings and net revenue.
Due to the coronavirus pandemic situation of 2020, PepsiCo benefited from at-home consumption of its snacks. Lay saw a 7% net revenue growth. However, PepsiCo Beverages North America reported an 11% operating profit decrease, which you can trace to a 1.5% organic volume decrease. This unit saw a 9% net revenue growth in Q4, recovering from the 7% sales drop it saw in Q3
Income Statement analysis
Pepsi’s market capitalization is currently $194.973B, and its book value per share is $9.75. Annual Revenue increased from $67.161B in FY2019 to $$70.372B in FY2020 for a 4.78% compound annual growth rate (CAGR). During the same timeframe, EPS declined from $5.2 to $5.12, a CAGR of -1.54%. In 2018, PepsiCo’s Diluted EPS saw a 159.76% increase from 2017, but in 2019, it saw a 40.77% decrease from 2018. PepsiCo Inc.’s operating profit increased from $10,291B to $10,110B from 2018 to 2019 but then decreased from $10,110B to $10,080B in 2020.
The companies income before income taxes decreased from $9,189B in 2018 to $9,069B in 2020. PepsiCo Inc.’s net income attributable to PepsiCo decreased from $12,515B in 2018 to $7,120B in 2020. PepsiCo’s effective tax rate decreased from 21.04% to 20.88% in 2020. (Note that these numbers are in USD million)
Operating Margin is calculated as Operating Income divided by Net Revenue. Simply put, Operating Martin is an important indicator of whether a company has problems. This is because operating margin declines before a company’s profit or revenue declines. PepsiCo Inc’s operating margin has been in a 5-year decline with a -1.3% average rate decline per year. PepsiCo’s operating income for 2020 was $7.12B, a 2.65% decline from the $7.314B of 2019.
PepsiCo’s Gross Profit Margin is 54.9%, and according to Finbox, it is better than the average Gross profit margin for the companies’ peers that is 33.9%. It means that PepsiCo’s Gross Profit Margin ranks in the 84.2% percentile for the sector.
Balance Sheet
A company’s balance sheet provides investors, analysts, and creditors with information on its assets, equity, and liabilities. It also indicates cash flows from inventories and receivables and information about their assets’ future earnings capacity. A strong balance sheet is important for a sustainable dividend.
In FY2020, PepsiCo reported a Total Current Asset of $22.2B, an increase from $17,64B of 2019. PepsiCo also reported a Total Asset of $92.918B, an 18.3% increase from the $78.547B of 2019. The companies Total Liabilities for 2020 were $79.366B, a 24.63% increase from the $63.679B of 2019. PepsiCo’s long-term debt for 2020 was $40.37B, a 38.5% increase from 2019. PepsiCo also reported a tangible book value of $-17.84 per share data.
Quite often, a company acquires another company and pays a price exceeding the acquired company’s tangible book value. The acquiring company reflects the difference between the purchase price and tangible book value of the acquired company on its balance sheet as “Goodwill”. When the ‘Goodwill’ component of a company’s Balance Sheet increases over time, it is a signal that the company is in acquisition mode. The Goodwill/Total Assets ratio amounted to ~20% in FY2020 versus ~23% in FY2011.
Debt analysis
PepsiCo’s debt levels are at US$44.57b, with $6.69b in current debt and $37.88b in long-term debt. It might seem like a lot, but it is not so bad since PepsiCo has a market capitalization of US$194.97b and can raise capital to strengthen its balance sheet if needed. Whether or not it can manage its debt without dilution is another matter.
We calculate a company’s net debt divided by its EBITDA (earnings before interest, tax, depreciation, and amortization) to find its debt relative to its earnings. PepsiCo has a net debt to EBITDA of 2.6, which is a noticeable amount of debt. Its EBIT, which has been flat over the past few months can kick-start earnings growth, thereby diminishing its debt load.
PepsiCo’s total debt/equity is 338% which is also fairly high. Typically the total debt/equity and net debt/ EBITDA are higher than I would like but the company does generate sufficient cash flow. The interest coverage is above 9 which means that the company can service the interest on its outstanding debts.
Risk Assessment
In May 2020, Moody’s affirmed PepsiCo’s A1 unsecured rating following the review initiated after the company announced the acquisition of Rockstar Energy Beverages. The A1 rating reflects the company’s consistent free cash flow generation, strong liquidity and business model, and customer and geographic diversity. Moody’s also confirmed PepsiCo’s Prime-1 commercial paper rating. Moody’s affirmation of the A1 ratings shows their expectation that acquisitions and investments will continue to fortify PepsiCo’s operating profile. There is hope that PepsiCo will remain one of the solid businesses in the consumer products section. PepsiCo’s aggressive financial policy and its recent debt-funded acquisitions caused the weakness of the Financial Metrics in the rating category. But Moody’s foresees that growth investments will boost free and operating cash flow and will lead to boosting credit metrics over the next few years.
The acquisition of Rockstar and the national agreement to be the exclusive distributor of Bang Energy drinks in America places PepsiCo to benefit materially from one of the fastest-growing beverage categories in the world, Energy drinks. Rockstar distribution contract has s restriction that hinders PepsiCo in fully developing an energy strategy. Removal of these restrictions will allow PepsiCo to innovate its brands.
PepsiCo uses aggressive financial policy and acquisition strategy in a bid to enter higher growth categories and markets. This strategy has risks and will need decisive implementation of integration and growth plans.
Dividend Quality
PepsiCo declared a quarterly dividend of $1.0225 per share of PepsiCo common stock, a 7% increase from the 2019 dividend. This dividend became payable to its shareholders on March 31, 2021, at the close of business. PepsiCo started paying quarterly cash dividends in 1965 and has increased its annual dividend for 48 years consecutively.
This reason is why PepsiCo is in the S&P 500 as one of the dividend aristocrats. Its quarterly dividend of $1.0225 led to a dividend yield of 2.95%. Looking at the previous 5 years the company has a dividend compound annual growth rate of over seven percent (7.81%). The EPS payout ratio was a high 78% in fiscal 2020. PepsiCo has always had a high disbursement percentage and has paid out $5,427 million in dividends in the previous four quarters.
To me, PepsiCo’s dividend is unsustainable and indicates low dividend growth in the future. The dividend is still manageable, but it puts pressure on PepsiCo’s management to improve profitability which may cause them to make riskier moves.
Future Growth
Like I earlier said, PepsiCo’s growth strategy is market penetration and product distribution. The company recently made two acquisitions, Be & Cheery, $705 million, and RockStar Energy Beverages for $3.85 billion.
Purchasing Rockstar Energy Beverages was a good move since it would help expand into the energy drinks category. Be & Cheery is one of the largest online snack companies in China. They sell dried fruits, nuts, and other items. Buying Be & Cheery was a smart move as it would help PepsiCo expand in snacks.
There is no doubt that these acquisitions will boost future growth. An Allied Market Research reported that the market is expected to grow at an annual growth rate of 7.2% globally.
Valuation
Valuation is how to find out how much a company is worth. I used both intrinsic market price estimation and quantitative analysis of PepsiCo’s fundamentals to get its Real value. I also took PepsiCo’s management style, its current capital structures, and its overall leadership history to determine its valuation.
From the above, you will notice that PepsiCo is growing at a low rate. Simple valuation metrics and discount cash flow analysis show PepsiCo is trading at a high valuation level now. I am going to take 2020 free cash flow as a basis for calculating the company’s valuation. PepsiCo has had a slow growth in the last era, with net income increasing with a CAGR of 1.63% since 2010 and revenue increasing with a CAGR of 1.67%.
Looking at the growth rates over the last few decades, net income grew with a CAGR of 8.62% and revenue increased with a CAGR of 6.4%.
Enterprise value and Free Cash Flow are likely to fall to about $197.6B and $8.4B respectively. PepsiCo has a $136.42 per share Real Value, and its prevailing price is $141.28. These numbers mean that the company is fairly valued.
Conclusion
PepsiCo has paid a quarterly dividend since 1965 and has increased the dividend for 48 consecutive years, solidifying the company’s position as Dividend Aristocrat. PepsiCo’s goal is about rewarding shareholders with dividends and is supported by a stable business. My main concerns are the high payout ratios, High debt, and slow revenue and cash flow growth.
Disclosure :Derek has a position in Pepsi and has no plan to initiate a position in the next 72 hours
If you would like a copy of the template I use to perform fundamental analysis then feel free to grab your copy below. I explain how I use the template here!
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