After years of underperformance, PepsiCo (PEP) is well positioned to be an activist target. Given the animosity towards the CEO, its underperformance, and deep value discount, PepsiCo may very well find itself in a proxy fight with Billionaire Carl Icahn. Over the last half decade, the company has been roughly flat, while Coca-Cola (KO) appreciated by 48.8%. As an investor relations consultant, I believe that the firm's tainted brand name requires a corporate shakeup. I advise risk-averse investors to consider under-followed companies like Reed's (REED) and Full Motion Beverage (FMBV.PK). These two firms are incredibly undervalued and are well positioned to outperform broader indexes when press coverage improves.
In the meanwhile, larger firms will receive a disproportionate amount of attention. In this article, I will run you through my DCF analysis on PepsiCo and then triangulate it with an exit multiple calculation and a review of the fundamentals compared to Coca-Cola and Dr. Pepper (DPS). Again, I find that battered brand has a deep value discount.
First, let's consider PepsiCo's revenue. The company finished FY2011 with $66.5B in revenue, which represented a 15% gain off of the preceding year. Analysts model a 6.15% per annum growth rate over the next half decade. I view this as overly conservative, since it is almost half of what is expected for the S&P 500.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat 46% of revenue versus 35% for SG&A and 5% for capex. Taxes are estimated at 26% of adjusted EBIT (accounting for non-cash depreciation charges).
We then need to subtract out net increases in working capital. I model this hovering around -0.7% of revenue.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 8.5% yields a fair value figure of $79.74, implying 22.1% upside. The market seems to be factoring in a WACC of 9.5%, which is overly high considering that the stock is 50% less volatile than the broader market and offers a 3.2% dividend yield. Too much risk that simply isn't there is thus being factored into the stock price, hence the need for a corporate shakeup.
All of this falls within the context of a better transformation than what the market acknowledges:
"We had broad-based gains in snack and beverage volume and net revenue. And we were able to achieve net price realization that partially offset the extraordinary commodity inflation we faced. More importantly, in 2011, we made disciplined investments in the business to generate long-term growth. We drove productivity through cost management. And more importantly, we were able to offset the impact in some of our markets, our skittish economy, natural disasters and political unrest with gains from some selective disposals of noncore businesses".
From a multiples perspective, PepsiCo trades at a respective 16.2x and 14.7x past and forward earnings versus 19.4x and 16x for Coca-Cola and 14.2x and 12.1x for Dr. Pepper. Assuming a multiple of 16x and a conservative 2012 EPS of $4.49, the rough intrinsic value of the stock is $71.84.
Consensus estimates for Dr. Pepper's EPS forecast are that it will grow by 13.3% to $2.72 in 2011 and then by 7% and 9.6% more in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $2.85, the rough intrinsic value of the stock is $45.60. Input inflation resulted in cost of goods sold being higher by $50M, reducing gross margins by 360 bps y-o-y. However, management is committed to returning free cash flow to shareholders. This was revealed by the 6.3% dividend raise and $522M worth of share repurchases in 2011.
I am also expecting considerable upside for Coca-Cola. The company has strong momentum with fourth quarter results being either in-line or well ahead of long-term internal growth targets. The firm's top brand name grants it a premium over peers, while international exposure significantly hedges against domestic volatility. Risk factors include soda tax and food policy changes, but there are little concerns in the way of competition. I strongly advise buying shares for a retirement portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.