Pepsi: An Undervalued Consumer Giant

| About: PepsiCo Inc. (PEP)

PepsiCo Inc. (NYSE:PEP) is a diversified beverage and snack company that sells a wide assortment of brand name products including Pepsi, Diet Pepsi, Mountain Dew, Gatorade, Aquafina, 7UP, Tropicana, and Sierra Mist. It also markets food products such as Doritos, Tostitos, Lays, Ruffles, Cheetos, Fritos, and additional products like Quaker oatmeal, Aunt Jemima mixes and syrups, Quaker Chewy granola bars, Quaker grits, Cap’n Crunch cereal, Life cereal, and Quaker rice cakes. PepsiCo was founded in 1898 and is headquartered in Purchase, New York. I feel that the company is one of several large cap firms within the consumer staples sector that offer a great opportunity for share appreciation. My positive investment thesis for PepsiCo is based upon nine key criteria, which include:

Key Selection Criteria

  1. A market capitalization over $10 billion.
  2. A leadership position within a growing industry.
  3. A dominant, or large, market share within its product mix.
  4. A strong position internationally.
  5. A strong balance sheet and high credit rating.
  6. A high free cash flow number.
  7. A low historical relative valuation as measured by price/sales and/or price/earnings ratios.
  8. A strong dividend growth rate.
  9. A catalyst of new revenue opportunities


PepsiCo is a large-cap consumer staples firm, with a current capitalization of $120 billion.


PepsiCo maintains a leadership position in many facets of the beverage and snack business. According to Beverage Digest, Pepsi maintains a 26% market share in non-alcoholic drinks, second only to Coca Cola's 34% market share. Among the top-10 products in the category, PepsiCo has the #3 and #4 brands with Pepsi and Mt. Dew. Among the top-10 brands, Coke and PepsiCo both have four. In the snack market, PepsiCo clearly dominates its competitors. PepsiCo is a single force in the domestic snack market, controlling nearly two thirds of the U.S. snack market alone. It also dominates Latin America with a 60% market share in fast growing Brazil. It leads in the United Kingdom (46% market share) and within continental Europe it maintains a healthy 31% market share. PepsiCo's portfolio of billion-dollar brand products is now 22. That number has doubled in ten years. PepsiCo's 22 billion-dollar brands are typically number one or number two in their respective category.


PepsiCo International Sales

Fiscal Total Revenue Intl.%Total
2008 43,251M 45%
2009 43,232M 46%
2010 57,839M 47%
2011 66,504M 50%

Source: PepsiCo Annual Report

North America still accounts for 75% of PepsiCo's profits, but carbonated beverages like its flagship line Pepsi and salty snacks are becoming harder to sell in today's health conscious developed markets. Fortunately, PepsiCo's international markets are now starting to take off. International revenue is a large portion of PepsiCo's revenue and has continued to rise over time. It has been enhanced from 45% of total sales in 2008 to 50% today. PepsiCo has focused energies on the international markets, as these markets are growing by three times traditional North American ones.

Between 2006 and 2011, emerging and developing market revenue has grown from $8 billion to $23 billion in total, with the mix increasing from 22 percent of revenues to 34 percent of the revenues over that same time frame. The company is continuing to accelerate international growth, especially through acquisitions and joint ventures. Two big Russian companies were brought into the fold in the past six years. In 2007, PepsiCo bought Lebedyansky, Russia's leading maker of juice. In 2011, Pepsi purchased Wimm-Bill-Dann. The latter was the largest beverage and snack company in Russia. In March of last year, PepsiCo completed a strategic alliance with leading Chinese food and beverage maker Tingyi Holding Corp. These major developments have focused PepsiCo's future on emerging markets, with a strong focus on the Russian and Chinese arenas.

Balance Sheet/FCF

The balance sheet of PepsiCo is in excellent condition. The firm maintains a credit rating of A from Standard & Poor's Ratings Service. This rating was affirmed this past October when PepsiCo issued GBP500 million senior unsecured notes due 2022. S&P commented on the new debt issue:

"Our rating on PepsiCo's senior unsecured debt continues to reflect our assessment of the company's business risk profile as "excellent" and financial risk profile as "intermediate." Key credit factors in our business risk assessment include the company's balanced portfolio of businesses, with its strong positions and well-known brands in the relatively stable, cash-generating liquid refreshment beverage and snack food industries, and geographic diversification"

2012 5765M
2011 5605M
2010 5196M
2009 4668M

Source: PepsiCo Annual Report

Free cash flow generation by PepsiCo has been consistent. Free cash flow has grown from $4.6 billion to $5.7 billion since 2009. In the past decade, PepsiCo has grown free cash flow by nearly 6% per year (3667M vs. 5765M). PepsiCo should generate nearly $6 billion in free cash flow next year. Although the acquisition of PepsiCo's North American bottlers increased the company's debt ($28 billion in 2012 vs. $8 billion in 2009), I view the firm's balance sheet favorably. Cash and investments for PepsiCo is stellar, rising from less than a billion in 2007 to over $6 billion this year.

Relative Valuation

As for relative valuation, I have a preference for price/sales ratio when examining the merits of a both healthcare and consumer product companies. PepsiCo is trading toward the lower end of its range in history in terms of price to sales. PepsiCo has traded at a price/sales ratio range of 1.4 to 3.2 in the past decade. The average price/sales ratio since 2004 has been 2.6. Sales per share have nearly tripled in the past ten years from 17.4 to 42.8. This was aided in large part by the purchase of the bottling companies and other international acquisitions. During the same time period, the share price of PepsiCo has not advanced by the same degree. The price of PEP in 2004 was $55 a share and has only risen by 40% in the past decade, a much slower rate than overall sales. Earnings have also risen substantially over the past decade, rising from $2.32 in 2004 to $4.05 this year.

PepsiCo has indicated that future sales growth should be at a mid-single digit rate, consistent with the last few years. Even at the moderate pace in sales per share growth over the next three years of 5%, PepsiCo could represent an excellent investment candidate. Combine the modest sales growth along with share reduction through stock buybacks, PepsiCo should generate healthy overall sales per share/SPS growth. Shares outstanding in PepsiCo have decreased from 1724M in calendar year 2004 to 1575M this year, a total decline of 8%. PepsiCo recently announced a new share repurchase program providing for the repurchase of up to $10 billion of PepsiCo common stock from July 1, 2013 through June 30, 2016. This succeeded the current repurchase program that was expiring on June 30, 2013.

Date Price/Sales Ratio Avg. Sales Per Share
2013 1.8 45.3 (exp.)
2012 1.6 42.8
2011 1.7 41.6
2010 2.0 36.6
2009 2.1 27.3

Source: PepsiCo Annual Report

With a $10 billion dollar buyback scheduled to be completed by 2016 along with consistent sales growth from expanding emerging markets, I expect PepsiCo sales per share to advance by 7.5% annually, from 45 today to just over 55 by mid-2016. Based upon an average conservative 2.25x price/sales ratio (below the median 2.4), my expected price for PepsiCo would be $123 a share within a three-year time frame. This would result in a $45 capital gain profit based on today's price of $78 a share. Importantly, this does not include dividends, which will be an additional component in total return for PepsiCo investors.

2016 SPS Projected 55
Price/Sales 2016 2.25
Target Price 2016 $123.75


There's no question that PepsiCo has an excellent dividend track record as the large beverage firm has been paying dividends since 1952 and has raised its payout for 40 consecutive years. Dividends have grown from .85 cents in 2004 to $2.12 a share in 2012. This is a compound growth rate of 15% per year, much above the average S&P 500 company rate of 8%.

PepsiCo Dividend Payout History - 6 Years

2007 2008 2009 2010 2011 2012
Dividends Per Share 1.43 1.60 1.76 1.89 2.03 2.12

Source: PepsiCo Annual Report

PepsiCo has a payout ratio of 50% of earnings. This range has been increasing over the preceding decade. In 2004, PepsiCo paid less than one-third of earnings in the form of dividends. Thus, a higher percentage of dividends to net income is not likely to continue. This should reduce the outstanding 15% growth rate down to a more manageable 6% per year. This is slightly below the average increase (7.5%) over the preceding couple of years. At this expected rate of increase, it would result in an additional collection of $2.23 (2013), $2.37 (2014), and $2.51 (2015) in dividends over the three-year period. The collection of $7.11 in dividends over the time period added to my capital gains projection ($45 share) would result in a total appreciation from both capital gains and dividends of 66% over a three year period. Notably, this also does not include reinvested dividends. As I have mentioned in previous articles, building wealth through dividend growth and reinvestment of dividends is a strong methodology for outperforming the markets over time.


In order for PepsiCo to advance its sales per share to 55 in three years, the firm must continue to maintain its leadership position in beverages and the snack market. It also must continue to accelerate sales growth in emerging markets as rising incomes throughout the world allow for more Western like consumer behavior. Acquisitions on the smaller end will supplement sales growth as well. Recently, rumours have been floated by the Daily Telegraph Publication that an activist investor, Trian Management has been buying shares in PepsiCo and Mondelez International (NASDAQ:MDLZ) perhaps to profit from a merger. However, in listening to management's conference calls over the preceding year, it seems unlikely PepsiCo would be interested in such a mega deal.

Pepsi has been a turnaround story for the last eighteen months. Its goals have been to stabilize the developed markets while increasing marketing spend and targeting emerging markets. Chief Executive Officer Indra Nooyi pledged in 2012 to enhance marketing and advertising by $500 million to $600 million in a bid to restore its brand awareness and set the company up for long-term growth. The money went into its core brands including Pepsi, Gatorade, Tropicana, and Mountain Dew, among others. In the latest earnings release, PepsiCo posted 5% organic revenue growth for the quarter and full year. The new funding for advertising had an impact as the top line results were favorable. More importantly, international growth continued to remain a strong catalyst for PepsiCo. PepsiCo's CEO Indra Nooyi indicated new growth came from strong emerging markets like Russia. She said, "We have a terrific position in Russia where we are the number one food and beverage business by a factor of two"

Russia really could be a difference maker for the firm. It now accounts for 7% of total revenue. PepsiCo has a long history with the Russian people. The company first came to Russia in 1974, fifteen years after the infamous picture of Nikita Khrushchev enjoying a Pepsi during the 1959 American National Exhibition in Moscow. Through its two primary acquisitions (mentioned above), Pepsi has now made the Russian market a primary growth driver. Organic revenue growth in Russia was 10% on a year-over-year basis in the most recent quarter. PepsiCo's products are ubiquitous in Russia, where its soft drink and snack products can be found in 98% of all retail outlets. PepsiCo not only can accelerate sales growth within Russia, but also with new potential customers within the former Soviet republics. CEO Nooyi spoke at length about this expansion for Bloomberg Businessweek Magazine. She commented, "Russia is just a base, You're doing it for the former Soviet Union countries. This is a business that is going to grow substantially. That's what fires everybody up." At the current pace of sales growth, Pepsi's Russian business could double by 2020.

Asia also offers compelling growth opportunities for PepsiCo. In 2012, Tingyi Holding Corp. one of the leading food and beverage companies in China, and its subsidiary Tingyi-Asahi Beverages Holding Co Ltd - TAB announced that the firm had created a strategic beverage alliance in China with PepsiCo. TAB will partner with PepsiCo's current bottlers to manufacture, sell and distribute PepsiCo's carbonated soft drinks. Co-branding its respective juice drink brands using the Tropicana brand name under license from PepsiCo is also part of the agreement. The combination of TAB and PepsiCo creates a beverage juggernaut within China, with a national distribution network in 70 plants. The alliance will have a strong stable of products, now tied in together, such as Pepsi, China's top-selling cola Mirinda, Gatorade, and the Master Kong brands of tea and water. With integration of the Tingyi deal largely complete, case volumes have begun to pick up for the joint venture. In September, carbonated soft drink volumes were up 15%. China is expected to become the world's largest beverage market by PepsiCo's analysis.

Snacks in emerging markets also have a large growth potential. According to analysis done by PepsiCo, consumer consumption of the salty snack category in emerging market like Russia and China are well below average. Russian and Chinese consumers only consume 28% and 11%, respectively, of what Mexican consumers do. The market for snacks in China is immense, at $12 billion annually. This is up from just over $8 billion in 2008. Although there are major competitors in China in the snack market (Want Want Group/Guangdong), share of the pie is bifurcated. No one company has over 10% market share. PepsiCo is behind the other firms in market share, but still resides in the top 5 with a strong, growing presence. The firm does have momentum and is building its brand. At the recent 2013 Superbrands China annual ceremony, PepsiCo's Lay's brand was named a "Superbrand China 2013," as one of consumers' favorite salty snacks in China for the year.

The case for PepsiCo is multifaceted. PepsiCo should be able to continue to generate revenue stability in its developed markets through normal price increases and by holding market share through additional marketing spend. Primary growth in sales should come from emerging markets. Currently 35% of total revenue, or nearly $23 billion dollars, comes from emerging and developing economies. If this revenue line can continue to grow at a double digit rate, by 2016 PepsiCo's emerging revenue sources would reach $30 billion. This could equate to nearly 40% of my total expected revenue ($75 billion). The firm pays an above average dividend yield, generates substantial free cash flow growth, and trades near a trough valuation based upon price/sales analysis. Although the stock has had a $10 a share run-up in the first few months of 2013, the stock still offers compelling three-year price upside. For a patient investor, a better entry point might be the mid-$70s.

Disclosure: I am long PEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.