PepsiCo, Inc. engages in the manufacture and sale of snacks, carbonated and non-carbonated beverages, dairy products, and other foods worldwide. It operates in four divisions: PepsiCo Americas Foods (PAF); PepsiCo Americas Beverages (PAB); PepsiCo Europe; and PepsiCo Asia, Middle East, and Africa (AMEA). The PAF division offers Lays and Ruffles potato chips, Doritos and Tostitos tortilla chips, Cheetos cheese flavored snacks, branded dips, Fritos corn chips, SunChips multigrain snacks, and Santitas tortilla chips in North America; Quaker oatmeal, Aunt Jemima mixes and syrups, Quaker Chewy granola bars, and Quaker grits, Capn Crunch cereal, Life cereal, Rice-A-Roni side dishes, Quaker rice cakes, Pasta Roni, and Near East side dishes in North America; and snack foods under Marias Gamesa, Doritos, Cheetos, Ruffles, Saladitas, Emperador, Tostitos, and Sabritas, as well as Quaker-brand cereals and snacks in Latin America. The PAB division manufactures beverage concentrates, fountain syrups, and finished goods under Pepsi, Gatorade, Mountain Dew, Diet Pepsi, Aquafina, 7UP, Diet Mountain Dew, Tropicana Pure Premium, Sierra Mist, and Mirinda brands; ready-to-drink tea, coffee, and water products; and concentrate and finished goods, as well as brands licensed from Dr Pepper Snapple Group, Inc. The PepsiCo Europe division offers snacks under Lays, Walkers, Doritos, Chudo, Cheetos, and Ruffles brands, as well as Quaker-brand cereals and snacks; and beverage concentrates, fountain syrups, and finished goods under Pepsi, Pepsi Max, 7UP, Diet Pepsi, and Tropicana brands, as well as ready-to-drink tea products in Europe. The AMEA division provides snack food under the Lays, Kurkure, Chipsy, Doritos, Smiths, and Cheetos brands; Quaker-brand cereals and snacks; and beverage concentrates, fountain syrups, and finished goods under the Pepsi, Mirinda, 7UP, Mountain Dew, Aquafina, and Tropicana brands.
Analysts expect PEP to grow earnings 4.25% per year for the next five years and I've assumed they can continue to grow at 3.50% per year thereafter, slightly above the long term inflation rate. Running these numbers through a DCF analysis with a 10% discount rate yields a fair value price of $66.23. This means that at $69.44 the shares are overvalued by 4.8%.
Over the last 12 months, Pepsi's EPS were $3.76 and it's current book value per share is $13.90. The Graham Number is calculated to be $34.29 which means it is currently overvalued by 102%.
Average High Dividend Yield:
Pepsi's average high dividend yield for the past 5 years is 3.39% and for the past 10 years is 2.75%. This gives target prices of $63.45 and $78.27 respectively based on the current annual dividend of $2.15. These are overvalued by 9.4% and undervalued by 11.3%, respectively. I feel that the 5 year average is going to be more typical of the yield going forward since the typical yield range has been steadily increasing since 2001.
Average Low PE Ratio:
PEP's average low PE ratio for the past 5 years is 14.81 and for the past 10 years is 16.86. This corresponds to a price per share of $60.14 and $68.47 respectively based off the analyst estimate of $4.06 per share for the fiscal year ending in December 2012. The 5 year and 10 year low PE price targets are overvalued by 15.5% and 1.4%, respectively.
Average Low P/S Ratio:
Pepsi's average low PS ratio for the past 5 years is 1.62 and for the past 10 years is 2.10. This corresponds to a price per share of $68.17 and $88.35 respectively based off the analyst estimate for revenue growth from 2011 to 2012. The 5 year and 10 year low PS price targets are overvalued by 1.9% and undervalued by 21.4%, respectively.
Dividend Discount Model:
For the DDM I assumed that PEP will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 4.80%. After that I assumed they can continue to raise dividends for the next 5 years at 75% of 4.80%, or 3.60%, and by 3.50% in perpetuity. The dividend growth rates are based off fiscal year increases and don't necessarily correspond to quarter over quarter increases. To calculate the value I used a discount rate of 10%. Based on this, Pepsi is worth $34.57 meaning it's overvalued by 100.9%
Pepsi's trailing PE is 18.47 and it's forward PE is 15.75. The PE3 based on the average earnings for the last 3 years is 17.79. I like to see the PE3 be less than 15, but PEP has historically been granted a premium based on the PE ratio. Compared to it's industry, PEP seems to be fairly valued versus KO (19.50) and overvalued versus DPS (14.85). Against the industry as a whole, Pepsi is slightly undervalued with the industry carrying a PE ratio of 20.92. All industry comparisons are on a TTM EPS basis.
PEP's gross margin for FY 2010 and FY 2011 was 57.9% and 56.4% respectively. They have averaged a 58.4% gross profit margin since 2001 with a low of 56.4% in their most recent fiscal year. Their net income margin for the same years were 10.9% and 9.7% respectively. I like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%. Pepsi is right on the cusp of the high ends for both gross and net margin. Margins are different across all industries and Pepsi is right around 100% of the gross margin for the industry but lacking in the net profit margin capturing only about 2/3rds of the industry level. This is mainly due to the fact that Pepsi is not a pure play for the beverage industry with a large portion of their sales and profit coming from the lower margin snacks business. Their cash-to-debt ratio for the same years were 0.20 and 0.30. Unfortunately the cash-to-debt position worsened between FY 2010 and FY 2011. I would like to see them make some headway on this front.
Pepsi's shares outstanding had decreased consistently between 2001 and 2008 but are currently above the levels from 2008. Despite the recent stagnation in shares outstanding they have averaged a 1.05% annual decrease since 2001. In FY 2011 they were able to continue decreasing their shares outstanding with another 1.08% decline. As long as management can continue to decrease the share count I would just consider the last few years a minor hiccup.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Pepsi is a dividend champion with 40 consecutive years of dividend increases. Their current annual dividend sits at $2.15 for a current yield of 3.10%. PEP's annual increase for the last 1, 3, 5 and 10 years have been 4.80%, 6.12%, 9.52% and 13.68%. These numbers are different from the actual quarterly increases since these are based off the dividend paid out during each fiscal year. Their payout ratio has slowly been increasing and has been around the 50% level for the past 4 fiscal years. Since 2001 they have averaged a 40.52% payout based on earnings. If the analyst estimates are correct then PEP will be paying out 52.5% of their earnings in dividends for FY 2012 which would be the highest ratio since 2001. While the payout ratio has been increasing it's still not in the danger zone with plenty of room for further increases. I would like to see the EPS growth increase since a company cannot continue to increase dividends at a rate higher than earnings forever.
Their FCF per share was great between 2001 and 2004 but since then dividends have exceeded the FCF. The following chart is one of my favorite graphs to use to see the growth in dividends, free cash flow and earnings as well as their relative positions. This is definitely something to check into further before investing with Pepsi.
Return on Equity and Return on Capital Invested:
Pepsi's ROE has averaged 34% since 2001 with a low of 28.5% and a high of 38.0%. Their ROCI is at a nice level as well averaging 25.1% since 2001 with a low of 15.3% and a high of 31.3%. For both ROE and ROCI I don't necessarily look for any absolute values rather I like to see stable or increasing levels. I'm a little worried about the ROCI dropping by about 40% for the last 2 fiscal years and would like to see how it turns out for FY 2012. If PEP can improve the ROCI it'll show that management has done a better job with investing their capital.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth, we'll now see how Pepsi has done. Their revenue has been on a great growth trend with only one down year since 2001. Over that time revenue has grown at a CAGR of 9.46%. Net income has grown at an annual rate of 9.24% since 2001. Since net income growth has been less than revenue growth their net profit margin has decreased from the highs of 16% in 2006 to the current 9.7% from FY 2011. Management has done a great job increasing revenue but needs to focus more on being able to turn more pennies into profit from every dollar they bring in.
Tangible Book Value:
Pepsi was doing a good job increasing their tangible book value per share from 2001 until 2007, but have since fallen on much harder times. Since 2009 they have gone from $5.38 in tangible bv per share down to $8.02. I wouldn't necessarily expect to see a positive value at the close of FY 2012 in December but I would like to see improvement on this front. The tangible book value per share is a measure of the per share value of all tangible assets owned by the company.
The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 5 years, 10 years or 16 whichever is least. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. In this case the target PE is 16.86 and the 0.75 PE is 11.11. This corresponds to a entry price of $77.08 and $45.10 based off the expected earnings for 2012 of $4.06. This means that Pepsi is trading at a $7.64 discount and $24.34 premium to the target prices. I don't think you'll see Pepsi trade for a PE of 11 unless the stock market takes a very big fall. That would be a 40% drop from current prices. Currently Pepsi is trading right at it's typical low PE ratio so based on that it is undervalued.
The average of all the valuation models gives a fair value $55.86 which means that Pepsi is currently trading at a 24.3% premium to the average fair value. I've also calculated the fair value with the highest and lowest valuation methods thrown out. In this case, the Average PE price and Graham number valuations are thrown out and the new average is $58.10. Pepsi is trading at a 19.5% premium to this price.
Overall I would say that Pepsi is fully valued at today's prices and doesn't leave much room for a margin of safety. I would feel better about initiating a position with Pepsi with a higher starting yield in order to compensate for the potential roadblocks ahead. A 3.50% yield corresponds to a price of $61.43 which would bring the starting value much closer to my fair value calculations. One caveat is that most of my calculations have a built in margin of safety and then I usually look for a margin of safety from the average of the valuation models. If revenue and therefore earnings growth can increase, then the dividend growth will follow. Pepsi is a great company with great future prospects, especially in China with YUM Brands continued expansion there, but the value just isn't there at today's prices for me. If you're interested in investing with Pepsi, then I would suggest looking at selling put options to try and get lower prices and at least get paid to wait. The only downside is that Pepsi is such a large company that the premiums will tend to be lower.
What do you think about PepsiCo as an DG investment at today's prices?