Coca-Cola, Pepsi, Procter & Gamble: Will These U.S. Multinationals Become Dividend Challenged?

Includes: KO, PEP, PG
by: Stephen Rosenman

Multinationals have been ramping up overseas business. Those foreign sales have contributed mightily to the bottom line, juicing dividend payouts. For instance, international consumer staples companies like Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), and Pepsi (NYSE:PEP) have burgeoning sales outside the United States. That's where their growth is, over there not here.

It's also where their money is. Each year, multinationals sell more goods elsewhere, racking up gigantic foreign earnings, all the more boosted by lighter overseas tax treatments. In contrast, American markets have not fared so well. Owing to higher U.S. taxation and consumers purchasing nonbranded names, consumer staples firms have not fared as well here. The outcome is that U.S. companies are piling up cash overseas and will find it difficult to access that capital easily. Simply, since multinationals choose not to repatriate overseas cash, they are limited here at home.

This piece is not meant to be a political discussion about the pros and cons of tax policy. Rather, my purpose (and discussion hopefully) is to understand how it impacts companies with a large overseas presence.

For dividend investors, it means the storied days of yearly dividend boosts may soon be over.

Despite strong overseas profits, U.S. multinationals are struggling to cover their dividends. In essence, dividends can only be paid by money earned or borrowed here in the U.S. Many consumer staples stocks are having trouble producing enough American earnings to fund the dividend. Some appear to borrow to make the dividend. I've already discussed Coca-Cola here-- it's hard pressed to continue raising dividends without borrowing.

For instance, in 2010, Coca-Cola's operating income derived from its North American segment came to $1.5 billion before taxes. It paid shareholders $4.1 billion in dividends, an amount significantly exceeding its U.S. profits.

Other consumer staples companies have the same problem. Take Pepsi. This softdrink and snack company has a thriving international business. However, Pepsi has elected to keep its foreign profits overseas. U.S. tax rules undoubtedly may play a role: Repatriated income would be taxed at a 35% rate minus foreign tax credits.

Per the 10K:

As of December 25, 2010, we had approximately $26.6 billion of undistributed international earnings. We intend to continue to reinvest earnings outside the U.S. for the foreseeable future and, therefore, have not recognized any U.S. tax expense on these earnings.

Therefore, without a change in policy, Pepsi's bountiful offshore income is off limits for the purposes of dividends, buybacks, or U.S. asset purchases. The company hasn't repatriated foreign earnings since the American Jobs Creation Act of 2004, when Pepsi brought back $7.5 billion and paid $460 million in taxes.

Pepsi has a demonstrated history of giving investors dividends. It's been raising them for years. Yet, its dividend now exceeds the earnings from its U.S. operations. Pepsi paid out $3 billion in dividends while earning about $1.6 billion in the U.S. While its overall dividend payout was 48%, its U.S. dividend payout reached over 180%.

(from 10Ks, foreign and U.S. earnings derived from yearly foreign earnings)

Clearly, Pepsi is good for the dividend. However, to cover it, the company finds itself in the awkward and unappealing position of borrowing the shortfall while its foreign moneys lie tantalizingly out of reach.

Procter & Gamble's U.S. earnings still cover its dividend. However, that is rapidly changing as the company seeks its growth overseas. The table below highlights Procter & Gamble's climbing dividend payout ratio on money made in the U.S. Payout based on U.S. earnings approached 85% for fiscal year ending June 2011.

(from 10ks, foreign and U.S. earnings derived from yearly foreign earnings)

American multinationals may become dividend challenged as their earnings become increasingly generated offshore. Investors seeking dividends may be wise to stick with companies that are less international and more U.S. focused. While multinational companies can look appetizing, much of their bottom line has yet to be U.S. taxed and, for all intent and purposes, is off limit when it comes to dividends.

Disclosure: I am long PG.

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