The share price of PepsiCo (PEP) has risen by 15% over the past 3 months, and the stock is currently trading at its 52-week high (see chart below). After the significant price appreciation, I think the stock is poised for a potential correction, and my view is backed by the following 5 reasons:
1. PepsiCo shares are somewhat expensive based on the company's financial performance relative to that of Coca-Cola (KO). According to the chart shown below, although PepsiCo's near-term consensus revenue, EBITDA, and EPS growth estimates are above those of Coca-Cola, the company's long-term earnings growth estimate is notably below Coca-Cola's. On the profit side, PepsiCo demonstrates a weaker performance as the firm's various profitability margins are below Coca-Cola's level. Its capital return metrics including ROE and ROIC are only marginally above the peer benchmark. In terms of debt and liquidity, both companies are in a healthy state and their performance is also fairly comparable.
PepsiCo stock is currently trading at 18.2x forward EPS (next 12 months), 4% below Coca-Cola's multiple at 19.0x. However, after accounting for the long-term EPS growth estimate, PepsiCo's PEG ratio of 2.2x is slightly above that of Coca-Cola. Given the PepsiCo's in-line capital return measures but inferior profitability margins, I believe PepsiCo's fair PEG level should trade at a discount to Coca-Cola's and as such the stock's current valuation appears to be modestly expensive on a relative basis (see chart above).
2. The forward P/E multiple gap between PepsiCo and Coca-Cola has compressed from 10% to 4% since a year ago (see chart below). The fact that PepsiCo has not demonstrated a better performance trend than Coca-Cola over the period suggests an increasingly pricey share value (as discussed later, PepsiCo's margins are in a downtrend).
3. The recent share price run-up appears to primarily driven by a rise of the overall market as opposed to the company's positive fundamental developments. Market's consensus revenue, EBITDA, and EPS estimates for 2013 and 2014 have mostly experienced downward revisions over the period, implying that the shares have actually become more expensive (see charts below).
4. As the speed of the share price appreciation is much faster than dividend growth, PepsiCo's dividend yield has declined all the way from its 3-year high at 3.4% to 3-year bottom at 2.7% (see chart below). The lower yield would likely attract less demand from income investors and thus reduce its cushion effect on the share price.
5. Further, PepsiCo's Q4 2012 operating result reveals a deteriorated margin performance. The company's quarterly gross, EBITDA, and net profit margins have all been slightly declining throughout the past 3 years primarily attributable to the lackluster performance of its beverage business (see chart below).
Bottom line, the robust share performance is difficult to be justified by PepsiCo's fundamentals and recent developments. As such, I believe the shares are currently overvalued and likely due for a pullback. I would suggest avoiding the shares for now or even taking a small short position as a speculative short-term play.
All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the charts and the article is sourced from S&P Capital IQ.