Why PepsiCo Is Better Than Coke For Dividend Investors

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 |  About: PepsiCo Inc. (PEP), Includes: KO
by: Bargain Bin

Coca-Cola (KO) is the world's largest non-alcoholic beverage company. The stock currently trades for $72.87 and has a projected yield of 2.8%.

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PepsiCo (PEP) also sells non-alcoholic beverages, but derives about 50% of its revenue from food. The stock currently trades for $65.35 and has a projected yield of 3.15%.

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Which of these beverage behemoths offers the best value for dividend investors? Let's look at the historical dividends for both companies.

Coca-Cola

Year Dividend Growth
2002 $0.80 11.11%
2003 $0.88 10%
2004 $1.00 13.64%
2005 $1.12 12%
2006 $1.24 10.71%
2007 $1.36 9.68%
2008 $1.52 11.76%
2009 $1.64 7.89%
2010 $1.76 7.32%
2011 $1.88 6.82%
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PepsiCo

Year Dividend Growth
2002 $0.595 %
2003 $0.63 5.88%
2004 $0.85 34.92%
2005 $1.01 18.82%
2006 $1.16 14.85%
2007 $1.425 22.84%
2008 $1.65 15.79%
2009 $1.775 7.58%
2010 $1.89 6.48%
2011 $2.025 7.14%
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In the last three years, dividend growth has been very similar for both companies. Let's look at the historical payout ratios. I will use percentage of the free cash flow instead of earnings to determine the payout ratio.

Coca-Cola

Year Free Cash Flow (Mil $) Float (Mil Shares) Payout Ratio
2002 $3,891 2,483 51.05%
2003 $4,644 2,462 46.65%
2004 $5,213 2,429 46.60%
2005 $5,524 2,393 48.52%
2006 $4,550 2,350 64.04%
2007 $5,502 2,331 57.62%
2008 $5,603 2,336 63.37%
2009 $6,193 2,329 61.68%
2010 $7,317 2,333 56.12%
2011 $6,554 2,323 66.63%
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PepsiCo

Year Free Cash Flow (Mil $) Float (Mil Shares) Payout Ratio
2002 $3,190 1,789 33.37%
2003 $2,983 1,739 36.73%
2004 $3,667 1,723 40.08%
2005 $4,116 1,669 40.95%
2006 $4,016 1,686 48.70%
2007 $4,504 1,656 52.39%
2008 $4,553 1,605 58.16%
2009 $4,668 1,577 59.97%
2010 $5,195 1,614 58.72%
2011 $5,605 1,597 57.70%
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The payout ratio for both companies have been very similar over the last three years, around 60%. This is higher than the historical values for both companies.

Valuation

I will use the Dividend Discount Model to put an estimated value on both companies. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I will assume that the dividend will grow by 8% next year for both companies, and then let that growth rate decay over 20 years to a perpetual growth rate of 3%, as per the growth table below.

Year Coca-Cola Dividend Growth Rate PepsiCo Dividend Growth Rate
2012 8.51%* 8%
2013 7.75% 7.75%
2014 7.5% 7.5%
2015 7.25% 7.25%
2016 7% 7%
2017 6.75% 6.75%
2018 6.5% 6.5%
2019 6.25% 6.25%
2020 6% 6%
2021 5.75% 5.75%
2022 5.5% 5.5%
2023 5.25% 5.25%
2024 5% 5%
2025 4.75% 4.75%
2026 4.5% 4.5%
2027 4.25% 4.25%
2028 4% 4%
2029 3.75% 3.75%
2030 3.5% 3.5%
2031 3.25% 3.25%
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*Coca-Cola has already announced dividends for 2012

Using these parameters, I arrive at an estimated fair value of $57.53 for Coca-Cola and $61.68 for PepsiCo. Coca-Cola is trading at a 26.67% premium to its estimated fair value while PepsiCo is trading at a 5.95% premium to its estimated fair value.

Conclusion

According to this dividend-based valuation, Coca-Cola is overvalued by over 25% while PepsiCo is trading much closer to its estimated fair value. PepsiCo is clearly the better option for dividend investors, offering a much better value than Coca-Cola.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.