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By Ahmed Ishtiaq

PepsiCo (NYSE:PEP) is the world's No. 2 carbonated soft-drink maker. Its soft drink brands include Pepsi, Mountain Dew, and their diet alternatives. Cola is not the company's only beverage: Pepsi sells Tropicana orange juice, Gatorade sports drink, SoBe tea, and Aquafina water. The company also owns Frito-Lay, the world's No. 1 snack maker with offerings such as Lay's, Ruffles, Doritos and Cheetos. The Quaker Foods unit makes breakfast cereals (Life, Quaker oatmeal), Rice-A-Roni rice, and Near East side dishes. Pepsi products are available in 200-plus countries; the U.S. generates 50% of sales. The company operates its own bottling plants and distribution facilities.

Dividend Profile

PepsiCo offers impressive dividends and a strong history of dividends. Currently, the firm has a dividend yield of 2.80%, and an annual dividend of $2.15 per share. PepsiCo has a long history of dividends, and the company has been increasing its dividend payouts at regular intervals. PepsiCo has a payout ratio of about 57%, based on free cash flows. In the past 12 months, the company paid cash dividends of $3.3 billion and generated free cash flows of $5.76 billion. In order to assess the dividend sustainability of the company, I take a deep look at the free cash flows and some important metrics.

Free Cash Flows

Free Cash Flows

2012

2011

2010

Net Income

$6,214

$6,462

$6,338

Depreciation and other noncash charges

$2,689

$2,737

$2,327

Funds from Operations (FFO)

$8,903

$9,199

$8,665

change in noncash current assets

$195

$159

$104

change in noncash current liabilities

$229

$96

$113

Operating Cash flows

$8,479

$8,944

$8,448

Capital Expenditures

$2,714

$3,339

$3,253

Free Operating Cash Flow

$5,765

$5,605

$5,195

SEC Filings

In the previous three years, net income has been volatile for PepsiCo; it went up in 2011 before coming down in the last 12 months. The same pattern is evident in funds from operations and cash flows from operations of the company. The cash flows from operations have improved slightly and currently stand at around $8.5 billion, compared with $8.45 billion at the end of 2010. PepsiCo invests a substantial amount of capital in the business, and in each of the previous three years, the amount of capital expenditures has remained around $3 billion. At the end of 2010, the firm spent $3.2 billion in capital expenditures; however, by the end of fiscal 2012 the capital expenditures for Pepsi had come down to $2.7 billion.

The company generates healthy free cash flows. A decrease in capital expenditures over the past 12 months has augmented free cash flows. The trend in free cash flows has been impressive over the past three years. Free cash flows for PepsiCo have gone up substantially from the levels of 2010. At the end of 2012, the company reported free cash flows of $5.76 billion, significantly higher than $5.2 billion reported at the end of 2010.

Essential Ratios

Essential Ratios

2012

2011

2010

Funds from Operations(FFO)/Total Debt

0.38

0.45

0.43

FFO/Capital spending requirements

3.28

2.76

2.66

Free Operating Cash Flow + interest expense/ Interest expense

7.41

7.55

6.75

Debt Service coverage

1.64

1.39

1.47

For my analysis, I have used four ratios. First ratio indicates that the debt of the company is adequately covered with the FFO. The ratio has shown a downward trend over the past three years. However, I believe the FFO-to-debt ratio is still adequate for PepsiCo. The firm is generating enough cash flow to cover the long-term debt. The second metric indicates that one of the most important components of the firm is easily covered with the FFO of the company. As I mentioned, capital expenditures are an integral cash outflow for PepsiCo, and the analysis shows that the firm is able to meet its capital spending requirements through its internally generated funds.

The last two metrics in the table indicate that the firm is able to meet its interest and debt payments sufficiently. PepsiCo has high levels of debt, and the debt levels have gone up over the past three years. The company reported long-term debt of just over $23.5 billion at the end of fiscal 2012. Furthermore, the debt service coverage ratios are solid for the company. These ratios indicate that the company does not face any immediate threat from its high levels of debt.

Summary

PepsiCo usually increases dividend payments once a year, and I expect the company to announce dividend increase soon. According to my analysis, free cash flows are strong for the company, and there is enough room in free cash flows for the company to increase dividends. Payout ratio for PepsiCo is manageable at the moment. On the other hand, the company enjoys certain cost benefits, which gives it advantage over its competitors. Furthermore, PepsiCo dominates the snacks industry, and it has a great distribution network. It can prove to be a solid investment and give a healthy stream of income.

Source: It Is Time For A Dividend Increase By PepsiCo