PepsiCo: The Dividend Growth Machine

| About: PepsiCo Inc. (PEP)

By Mark Bern, CPA CFA

PepsiCo (NYSE:PEP) is the world’s second largest food and beverage company. The company has 19 brands that contribute more than $1 billion in sales annually each. In 2000, that number stood at just 10 brands. Pepsi has developed into the P&G of the food and beverage industry by demonstrating that it can develop and grow one mega brand after another. There will be more mega brands in the future, I assure you. As the company continues to grow its presence in both emerging and developing nations, it is also creating and developing new brands that will become tomorrow’s new mega brands.

Pepsi is also cashing in on the cultural changes in the U.S., just as it has done in the past. As a growing number of Americans begin to make healthier choices for snacks, Pepsi is among the leaders in meeting these increasing demands. Pepsi’s Global Nutrition Group focuses on healthier options in juices, dairy and snacks. These products currently account for about 22 percent of its product portfolio. The eventual goal is 30 percent. The company knows that everyone won’t follow the trend, though, so it will continue to grow its core beverages and snack business globally through internal R&D and acquisitions.

The research in sweetener technology is paying off already. The all-natural zero calorie sweetener used in SoBe Lifewater Zero Calorie drinks has helped the SoBe brand grow its volume by 46 percent in 2010 and it continues to grow in 2011 (percentage break down not available in quarterly reports). This is only one example of the many ongoing efforts of Pepsi to create, develop and expand new brands.

The company derives more than 45 percent of its revenue from outside the U.S. and continues to grow that percentage, especially in emerging and developing markets from which it already originates 30 percent of company revenue. Pepsi has acquired bottling affiliates to more fully integrate its beverage operations and to gain greater access to and control over customer relationships. The company also made an investment in Russia of $3.8 billion by acquiring Wimm-Bill-Dann Foods (NYSE:WBD), which will expand Pepsi’s opportunity for growth in another developing country. This move has strategic implications for Pepsi in Russia, a nation with 142.9 million inhabitants and a growing middle class. This may represent less than half the population of the U.S. but it represent far greater potential for growth and profit as Pepsi deploys it superior quality controls and brand development skills to a new market where consistent, high quality is scarce. This is also an advantage Pepsi can leverage in other emerging and developing countries with even larger populations, like China, India, Indonesia and Brazil.

I don’t know what the market will do in the short or even the intermediate term, but I do know that those companies that consistently post higher earnings, rising dividends and maintain strong financial positions will see their stock prices rise over the long term. PepsiCo is among that elite group that can lay claim to a bright and prosperous future, in my opinion.

The company’s dividend has risen for 39 consecutive years and still has room to grow. The payout ratio is about 45 percent, leaving room for expansion in case the economy weakens again and earnings drop as they did in 2008. Earnings have grown consistently over the past 14 years with only that one year (2008) registering a slight decline of four percent. Earnings for Pepsi have grown at an average of nine percent over the past five years, even including the one-year dip. I expect earnings to continue to grow at about the same high single-digit level for the next five years, as well. And dividends should follow that same trend, but maybe at a slightly lower rate of perhaps five to six percent per year. The current dividend is $0.515 per quarter ($2.06 annually) at the current stock price (as of the market close on Thursday, December 1, 2011) of $64.09, providing a yield of 3.2 percent.

But there is more good news! The stock is undervalued based upon its historical price/earnings ratio average of 20. The current P/E is 16 which allows for additional multiple expansion and stock price appreciation.

When we add it all up (25 percent appreciation potential from P/E expansion, plus a dividend yield of 3.2 percent rising about six percent annually plus earnings growth averaging about nine percent per year) we get an annual expected total return of around 20 percent over the next five years. Now that is one thing even more satisfying than an ice-cold Pepsi on a hot summer day.

For a look at a comparison of Pepsi and Coke (NYSE:KO) please see an earlier article here.

That article also contains a link with an opposing view by another author for a contrasting view.

Disclosure: I am long PEP.