I reiterate my bullish stance on PepsiCo (PEP), as the company has attractive valuations in comparison to its peers, analysts have projected a high next five years growth rate of 8% per annum for the company, and it has been delivering solid financial performance in the past. Also, PEP has been taking initiatives to improve upon its operational efficiencies and has been undertaking investment spending that will portend well for the company's long term financial performance. The stock also offers a potential price appreciation of 10.5%, based on my price target of $92 (calculations shown below).
PEP has been delivering better-than-expected financial performance in the recent times. The company has posted the eighth consecutive quarter of earnings beat in 3Q2013. Last week, PEP reported a healthy financial performance for 3Q2013; it reported a core EPS of $1.24, up 3% year-on-year, beating consensus estimates of $1.17. Earnings for the quarter were positively affected by lower-than-expected reinvestment in Vietnam and a favorable tax rate for the quarter. The following table shows the positive earnings surprises registered by the company in the last four quarters.
Source: Yahoo Finance
For 3Q2013, total revenues increased by 1.5% year-on-year to $16.91 billion, missing consensus estimates of $17 billion. Total revenues for the quarter were adversely affected by beverages re-franchising transactions in Vietnam and China. Also, foreign currency movements shaved away approximately 1% from total revenues. However, excluding these factors, organic revenues increased by almost 3% for the quarter. Other than a decent organic revenue growth of 3%, the company experienced core constant currency operating profit growth of 3%. The following table shows revenues and operating profit growth for PEP's reporting segments.
Organic Revenue Growth - YoY- 3Q2013
Core Constant Currency Operating Profit Growth - YoY - 3Q2013
Source: Earnings Release
Most of the company's segments showed strength in the recent third quarter, while weaker results were experienced in North America Beverages and AMEA. The North America Beverages segment has been struggling to grow volumes due to a decline in CDS sales, and the AMEA segment's results for the quarter were adversely affected by an aggressive pricing environment in India and political unrest in Egypt.
Key Stock Price Catalysts
The company has working to improve the performance of the North America Beverages segment given the weak volume growth in CDS for the segment; the segment has great value, provides a scale for global operations, and is likely to turn profitable again once the re-franchising is complete. The company has been re-franchising bottlers and has been investing heavily to improve upon its supply chain from top-to-bottom, which is expected to have a positive impact on the North American Beverage segment's earnings in the weak volume growth environment. I believe PEP will announce additional structural changes and productivity savings in early 2014 to strengthen the segment's bottom line results. PEP's ongoing efforts to strengthen the segment's results are expected to result in cost savings of approximately $1 billion in 2013. The savings, which the company is likely to enjoy as a result of its ongoing restructuring efforts, are likely to be reinvested in available growth opportunities.
The company plans to increase its investment spending in its key markets to benefit from potential growth opportunities. PEP is anticipated to spend $0.05 per share in the final quarter of 2013. The investment spending is likely to be directed towards developing market infrastructure, which will have a positive impact on the company's future earnings.
PEP has also been ramping up its advertisement and marketing (A&M) spending to strengthen its consumer loyalty and survive the intense competitive environment prevalent in the industry. PEP has a lower A&M-to-sales ratio in comparison to its peers, which provides the company with the potential to further increase its A&M spending, which will portend well for the company. A&M spending for PEP had increased by 13% and 8% year-on-year in 2Q2013 and 3Q2013, respectively. The following graph shows the A&M-to-sales ratio comparison between PEP, Dr Pepper Snapple Group (DPS) and Coca-Cola Company (KO).
Source: Company Reports and Calculations
I reiterate my bullish stance on PEP. The company has attractive valuations in comparison to its peers and offers investors a potential price appreciation of 10.5%, based on my price target of $92.
PEP has attractive valuations in comparison to its peers. It has a lower PEG of 2.4, in contrast to KO, which indicates that it offers cheaper growth. Moreover, PEP has a higher next five years growth estimate of 8% and a higher ROE of 30.5% in comparison to DPS and KO (as shown below in the table).
5 Year Growth Rate
Source: Yahoo Finance
Furthermore, the stock offers a potential total return of almost 13%, based on my price target of $92; a potential price appreciation of 10.5% and a dividend yield of 2.7%. I calculated the price target of $92, using the S&P 500 forward P/E of 16.2x and by applying a 20% premium to it due to PEP's significant international market exposure. I also used the 2014 EPS estimate for the calculation of the price target.
2014 EPS est