Updated on February 28th, 2019 by Bob Ciura
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 the Dividend Aristocrats each year. To conclude the 2019 series, we will review food and beverage behemoth PepsiCo (PEP).
The stock offers a solid 2.8% dividend yield, and has increased its dividend for 46 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.
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.
In its current form, PepsiCo came together as a result of the 1965 merger of Pepsi-Cola and Frito-Lay.
Today, PepsiCo is a global food and beverage giant. It has a market capitalization of $163 billion, and generates more than $63 billion of annual revenue.
PepsiCo’s business is nearly equally split between its food and beverage segments. It is also balanced geographically, between the U.S. and the rest of the world.
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.
Source: Investor Presentation
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.
PepsiCo released financial results for the fourth quarter and full year 2018 on 2/15/2019. Organic revenue (which excludes the impact of currency) increased 4.6% for the fourth quarter. Along with revenue growth, margin expansion, share repurchases, and tax reform resulted in 17% adjusted earnings-per-share growth for the quarter.
For the year, organic revenue increased 3.7%, while PepsiCo produced 9% adjusted EPS growth for 2018.
PepsiCo has a long history of steady growth. Even in a challenging environment for soda, PepsiCo has continued its consistent growth. An illustration of the company’s performance since 2012 can be seen in the below image.
Source: Investor Presentation
Going forward, 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.
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.
Competitive Advantages & Recession Performance
PepsiCo has numerous competitive advantages. Among them, are strong brands, and global scale. According to Forbes, Pepsi is the #29 most valuable brand in the world. Frito-Lay takes the #41 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 nearly $4 billion in R&D from 2011-2017, to innovate new products and packaging designs. In addition, PepsiCo regularly spends more than $2 billion each year on advertising, to maintain market share and build brand equity with consumers.
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 is 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:
- 2007 earnings-per-share of $3.34
- 2008 earnings-per-share of $3.21 (3.9% decline)
- 2009 earnings-per-share of $3.77 (17% increase)
- 2010 earnings-per-share of $3.91 (3.7% increase)
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 is expected to generate earnings-per-share of $5.50 in 2019. Based on this, the stock trades for a price-to-earnings ratio of 21.1. This is slightly above its 10-year average price-to-earnings ratio of 18.7.
Our fair value estimate is a price-to-earnings ratio of 18.9. Based on this, the stock appears overvalued. A declining price-to-earnings ratio could reduce annual returns by 2.2% each year.
As a result, future returns will likely be comprised of earnings-per-share growth, and dividends. We expect PepsiCo to grow earnings-per-share each year by 5%-6%, consisting of organic revenue growth, acquisitions, modest margin expansion, and share repurchases.
PepsiCo also has a 3.2% current dividend yield. The combination of valuation changes, earnings growth, and dividends results in total expected returns of 6.5% per year over the next five years.
PepsiCo has a secure dividend, with a projected dividend payout ratio of 69% for 2019. This gives PepsiCo enough room to continue increasing the dividend at a high-single digit rate each year.
PepsiCo is a very strong business, with a number of category-leading brands. By investing heavily in new products and acquisitions, it is likely to continue growing sales and earnings for many years.
Shareholders should continue to benefit from PepsiCo’s strong business through annual dividend increases. 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.