Dividend Aristocrats in Focus Part 49: PepsiCo - Sure Dividend Sure Dividend

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Dividend Aristocrats in Focus Part 49: PepsiCo

Published by Bob Ciura on November 23rd, 2017

As the saying goes, slow and steady wins the race. This phrase comes to mind when reviewing the Dividend Aristocrats, a select group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.

We review all 51 Dividend Aristocrats each year. Next up is food and beverage behemoth PepsiCo (PEP).

PepsiCo is one of 350 dividend-paying stocks in the consumer staples sector. You can see the full list of all 350 consumer staples dividend stocks here.

The stock offers a solid 2.8% dividend yield, and has increased its dividend for 45 years in a row. The company’s dividend is very safe and is suitable for risk-averse income investors. You can watch a video analysis on Pepsi’s dividend safety below:

PepsiCo’s valuation is not a screaming bargain right now, but it is rarely a dirt-cheap stock.  The company appears to be trading around the high end of fair value at current prices.

Business Overview

In its current form, PepsiCo came together as a result of the 1965 merger of Pepsi-Cola and Frito-Lay.

Pepsi-Cola was created in the late 1890s by Caleb Bradham, a North Carolina pharmacist. Meanwhile, Frito-Lay, Inc. was formed in 1961 from the merger of Frito Company, and the H. W. Lay Company.

Today, PepsiCo is a global food and beverage giant. It has a market capitalization of $163 billion, and generates more than $62 billion of annual revenue.

PepsiCo’s business is nearly split between its food and beverage segments. It is also balanced geographically, between the U.S. and the rest of the world.

PEP Overview

Source: 2016 Annual Report, page 14

PepsiCo has a large portfolio, and owns many popular brands. Some of the company’s major brands include Pepsi and Mountain Dew sodas, as well as non-sparkling beverages like Pure Leaf, Tropicana, Gatorade, and bottled water.

In addition to PepsiCo’s core beverage brands, it also has a large snacks business under the Frito-Lay brand. The company has also built a portfolio of healthier foods, including Quaker, Naked, and Sabra.

PepsiCo’s diverse portfolio has served the company well. It has products that cater to all tastes, across the health spectrum.

2016 was another good year for PepsiCo. The company increased organic revenue and adjusted earnings-per-share by 3.7% and 9%, respectively, for the year. There is potential for continued growth moving forward.

Growth Prospects

Two of PepsiCo’s most promising catalysts are growth in healthier foods and beverages, and in the emerging markets.

Sales of soda are slowing down in developed markets like the U.S., where soda consumption has steadily declined for over a decade. As a result, large soda companies like PepsiCo have had to adapt to a more health-conscious consumer.

PepsiCo has shifted its portfolio toward healthier foods that are resonating better with changing consumer preferences.

PEP Transforming

Source: 2017 CAGNY Presentation, page 3

In addition, PepsiCo has a huge growth opportunity in emerging markets like China, Africa, India, and Latin America. These are under-developed regions of the world, with large consumer populations and high economic growth rates.

For example, over the first three quarters of 2017, organic revenue increased 6% in Latin America, along with 4% growth in the Asia, Middle East, & North Africa segment. This far exceeded the 1% decline in North America beverage sales in the same period.

As a result, 2017 has been another strong year for the company thus far. PepsiCo grew organic revenue and adjusted earnings-per-share by 2.3% and 9%, respectively, over the first three quarters.

For 2017, PepsiCo expects organic revenue growth of 3%. In addition to cost cuts and share repurchases, this is likely to fuel adjusted earnings-per-share growth of approximately 7.8% for the full year.

Competitive Advantages & Recession Performance

PepsiCo has numerous competitive advantages. Among them, are strong brands, and global scale. According to Forbes, Pepsi is the #30 most valuable brand in the world. Frito-Lay takes the #40 spot.

In all, PepsiCo has 22 individual brands that each collect at least $1 billion in annual revenue. Strong brands give PepsiCo optimal shelf space at retailers, and give the company pricing power.

PepsiCo’s financial strength also allows the company to invest in research and development, as well as advertising, to retain its competitive advantages. For example, PepsiCo invested $3.5 billion in R&D from 2011-2016, to innovate new products and packaging designs.

Plus, PepsiCo spends billions each year on advertising:

PepsiCo’s competitive advantages and strong brands allow the company to be highly profitable, even during recessions. Food and beverages always retain a certain level of demand, which why the company held up so well during the Great Recession.

PepsiCo’s earnings-per-share throughout the Great Recession of 2007-2009 are listed below:

As you can see, PepsiCo’s earnings-per-share declined only modestly in 2008. The company proceeded to grow earnings by nearly 20% in 2009, which is very impressive. Earnings continued to grow once the recession ended.

Valuation & Expected Returns

PepsiCo expects to generate earnings-per-share of $5.23 in 2017. Based on this, the stock trades for a price-to-earnings ratio of 21.9. This is slightly above its 10-year average price-to-earnings ratio, of 18.7.

PEP Valuation

Source: Value Line

However, this does not automatically render PepsiCo an overvalued stock. Because of its high-quality brands and strong earnings growth, PepsiCo deserves a premium valuation. While PepsiCo is not a cheap stock, it does not appear overvalued, either.

Still, investors cannot count on PepsiCo’s valuation multiple to rise beyond its current level. As a result, future returns will likely be comprised of earnings-per-share growth, and dividends.

If PepsiCo can maintain its rate of high-single digit earnings growth going forward, total returns might look like this:

In this forecast, total returns would reach approximately 7% to 10% per year, including dividends.

PepsiCo’s dividend is highly secure. The current annual dividend of $3.22 per share represents a payout ratio of 61%, using 2017 expected earnings-per-share.

This gives PepsiCo enough room to continue increasing the dividend at a high-single digit rate each year.

Final Thoughts

PepsiCo is a very strong business, and is a likely candidate to continue increasing its dividend each year. The stock is not deeply undervalued, which means value investors might want to wait for a more attractive entry point before buying shares.

That said, PepsiCo remains a valuable holding for a dividend growth portfolio.

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