PepsiCo (PEP) is the world's second-largest food and beverage company. The company has posted healthy financial performances in the past. I remain bullish on the stock, as it has attractive valuations (as shown below) as compared with its peers, and analysts have projected a high next five-year growth rate of 8.3% per annum for PEP. Also, the company has been increasing its business investment to tap available growth opportunities, which remain an important stock price driver for the company. Moreover, based on my price target of $86 per share, it offers investors a potential price appreciation of almost 10%.
The company has been working to improve upon its productivity, which will positively impact its bottom line results. PEP has also been increasing its business investments to tap available growth opportunities and strengthen its product portfolio. In the process of strengthening its product portfolio, the company has been focusing on offering healthy products to its customers. The company has markets in more than 200 countries around the world. It has a diverse product portfolio, which includes 22 brands, each generating more than $1 billion in annual revenues.
The company has been posting better-than-expected results in the recent quarters; in 2Q2013, PEP posted the seventh-consecutive quarter earnings beat. In the recent second quarter, PEP reported a core EPS of $1.31, up 17% YoY, ahead of analyst consensus estimates of $1.19 per share. Core gross margin expanded for the company by 120bps in 2Q2013. The following table shows the earnings surprises posted for the last four quarters.
Earnings Surprise %
Source: Yahoo Finance
PEP also posted strong top line results in 2Q2013; organic revenue grew by almost 4.2% YoY. Core operating profit on constant currency increased by 11% YoY in 2Q2013. The following table shows the growth in revenues and operating profit for different reporting segments of the company.
2Q'13 Organic Revenue Growth YoY
2Q'13 Core Constant Currency Operating Profit Growth YoY
Key Stock Price Catalysts
The company has been working to improve its productivity, which will have a positive impact on its future earnings. Reorganization of North America beverages, and the consolidation of production and distribution facilities are expected to result in potential cost savings of almost $1 billion this year. The company initiated its three-year productivity program in 2012, which is expected to result in total productivity savings of up to $3 billion by 2014. It has also been working at identifying the next generation of productivity initiatives for the years beyond 2014. The productivity savings that are likely to be enjoyed by PEP in the future provide an opportunity for reinvestment behind available growth opportunities.
PEP is committed to increasing its investment spending to tap available growth opportunities in key markets, strengthening its product portfolio and building on consumer loyalty. It has plans to spend an additional $0.07 per share in investment spending in 2H2013. Investment spending will mainly be directed toward developing its market infrastructure in its high-growth international markets. The company's management indicated that advertisement and marketing spending would increase in line with its top line growth. However, I believe advertisement spending for the ongoing year (2013) will outpace the company's top line growth as advertisement spending increased by 13% in the recent second quarter.
PEP has the potential to increase its advertisement and marketing (A&M) spending, as its A&M to sales ratio is below its peers in the industry. The following chart shows the A&M to sales ratio comparison between PEP, Coca-Cola Company (KO) and Dr Pepper Snapple Group (DPS).
Source: Companies Reports
PEP reaffirmed its guidance outlook for 2013. It expects core constant currency EPS growth of 7% and organic revenues growth to be in mid-single digits for 2013. The company's management expects foreign currency exposure to have an adverse impact of 2% on EPS in 2013, up 1% from the prior estimate.
The company has been sharing its successes with its shareholders; it is expected to return almost $6.4 billion to its shareholders through share repurchases and dividend payments. And it expects to generate $9 billion in operating cash flows in the ongoing year.
The company was able to post a better-than-expected financial performance in 1H2013. Earnings growth for the company is likely to slow down in 2H2013 as compared to 1H2013 due to commodity cost inflation, higher business investment and a higher tax rate. In the recent second quarter, PEP realized a tax benefit of almost $0.03 per share, which will reverse in 2H2013.
Analysts are anticipating a high next five-year growth rate of 8.3% for PEP. Following are the analysts' EPS estimates from 2013 through 2016.
The company has delivered strong financial performance in the past, and the stock remains attractive at current valuations. The table below shows that PEP has attractive valuations in comparison to its peers.
5 Year growth est.
Source: Yahoo finance
PEP has a lower PEG of 2.2 as compared to KO of 2.3, which indicates that PEP offers cheaper growth. Also, the company has a higher 5-year growth rate of 8.30% and ROE of 31% in comparison to its peers, as shown in the table above. Also, the recent pullback in PEP's share price offers investors a good entry point to buy the stock; the stock is down almost 7%, since July 18, 2013.
I calculated a price target of $86 per share for PEP. I used the S&P 500 forward P/E of 15.05x and applied a 20% premium to it, due to PEP's strong market position and significant international market exposure. I further used the 2014 EPS estimate of $4.74. Based on my price target of $86, the stock offers potential price appreciation of almost 10%.
2014 EPS est.
15.05x*1.2 = 18.10x