Why PepsiCo Looks Overvalued Compared To This Sub-Industry Peer

| About: PepsiCo Inc. (PEP)


We’re focusing on PepsiCo in this article and assessing its strengths and weaknesses.

Specifically, we’re looking at its income potential, growth prospects and profitability.

Valuation also forms part of our analysis and we find that PepsiCo could be overvalued compared to a sub-industry peer.

In this article we're focusing on PepsiCo (NYSE:PEP) and asking whether shares in the company are attractive when compared to Monster (NASDAQ:MNST). We've chosen Monster as a comparator because, although a lot smaller (its market cap is just $14 billion versus $138 billion for PepsiCo) the two companies sit in the same GICS sector of consumer staples, as well as the same GICS sub-industry of soft drinks. We appreciate that many investors apportion their capital based on GICS sub-industries, so feel that a comparison between the two companies could be useful and worthwhile.

Income Potential

The first thing that struck us when analyzing PepsiCo is just how much potential it has to be a top income play. Shares in the company yield a surprisingly attractive 2.9% (forward yield), which is only just below the key 3% level that we know many investors look out for. However, where the real potential lies is in PepsiCo's payout ratio, with it being just 51% right now. Sure, the company needs to reinvest in new plant and machinery, as well as research and development, but we think that PepsiCo could be far more generous with regard to its dividend per share payments than it currently is. Doing so would mean a higher dividend for investors, and would make PepsiCo an even more attractive income proposition.

Contrast this to Monster, which pays no dividend, and it's clear that PepsiCo is the more attractive income play at present. Of course, there is potential for Monster to pay a dividend: it's certainly profitable enough, but the payout ratio (when it does move upwards) is likely to move up slowly and is unlikely, therefore, to make Monster a quick-hit dividend stock.


Furthermore, PepsiCo remains hugely profitable. For example, its return on equity was 29.7% last year, which is hugely impressive. Sure, a relatively high debt to equity ratio of 139% helps the return on equity figure, but we're comfortable with PepsiCo's current debt levels, since the company's interest coverage ratio was an impressive 10.8 last year. This shows that PepsiCo has adequate headroom when servicing its debt, so rising interest rates shouldn't cause too much of a problem. In addition, PepsiCo's return on assets figure of 8.1% shows that it's working its asset base very efficiently, while operating margins of 15.4% show that the company's supply chain is also efficient, with its cost base being kept at a minimum.

Although we're impressed with PepsiCo's figures, we're even more impressed with Monster's. That's because, unlike PepsiCo, Monster has no debt on its balance sheet, so a return on equity figure of 38.3% is mightily impressive. Furthermore, return on assets of 26.8% is above and beyond PepsiCo's 8.1% equivalent, and shows that while PepsiCo may be efficient, Monster is far more so. Meanwhile, an operating margin of 28.1% again shows that it is Monster, and not PepsiCo, that is the more profitable of the two companies.

Growth Potential

It's the same story when it comes to earnings growth prospects. PepsiCo is set to post reasonable numbers this year and next year, with the company's bottom line due to increase by 3.6% this year and by 8.1% next year. However, PepsiCo again loses out to its sub-industry peer, with Monster forecast to deliver earnings growth of 21.6% this year and 15.8% next year. Sure, we like PepsiCo's growth numbers, but we like Monster's even more!


We feel that PepsiCo could be overvalued relative to its sub-industry peer. That's because, while PepsiCo does have better income prospects, it lags behind by a large amount when it comes to earnings growth forecasts and profitability. So, we'd expect PepsiCo to trade at a significant discount to its more nimble and more efficient sub-industry peer.

However, PepsiCo trades on a 5-year PEG ratio of 2.7, while Monster's equivalent figure is just 2.3. Sure, PepsiCo's forward P/E is lower than Monster's at 18.6 versus 29.9, but when longer term growth forecasts are taken into account, PepsiCo doesn't seem to offer good value for money when compared to its smaller peer.

The Coca-Cola Connection

Of course, the major recent news surrounding Monster is that Coca-Cola (NYSE:KO) has taken a 16.7% stake in the company (subject to regulatory approval). The deal means that Coca-Cola will transfer its energy drinks business to Monster, with Monster's non-energy drinks business heading in the opposite direction. We think the move could be good news for Monster, mainly because it gives the company access to Coca-Cola's worldwide distribution network, which is highly efficient and widespread. It also means that Monster has one less rival to worry about, in terms of Coca-Cola now not competing with the company when it comes to energy drinks (which have long been Monster's specialty). As a result, we believe that the deal could make Monster even more profitable going forward. As for Pepsi, the deal could pit the company against a stronger and bigger rival, which could harm the company's bottom line in future.


Although we're impressed by PepsiCo's income potential, with shares in the company currently having a forward yield of 2.9% and a payout ratio of just 51%, we feel that it lags behind sub-industry peer, Monster, when it comes to profitability and growth potential. As such, we think that despite PepsiCo having a lower forward P/E than Monster, that when growth forecasts over the longer term are taken into account PepsiCo appears to be overvalued relative to Monster. As such, we believe that shares in PepsiCo could underperform those of Monster moving forward, as the market reacts to what appears to be a mispricing going forward.

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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.