Shares of PepsiCo Inc. (PEP) have posted a solid return of 13.97% over the past 12 months. The stock is currently trading at very close to the 52-week high of $73.66 and has a decent dividend yield of 2.9%. Will the upward price trend continue? My conclusion is that there may be a price correction down the road as the elevated stock valuations are somewhat hard to be supported by the company's fundamentals. In this article, I will walk you through some thoughts that helped in formulating my investment decision.
The value analysis performed below includes a set of PEP's comparable peers such as The Coca-Cola Company (KO), Nestle (OTCPK:NSRGY), and Dr Pepper Snapple Group, Inc. (DPS). The estimated stock value is determined by equally weighting the valuations calculated by five different peer-average trading multiples - EV/Sales, EV/EBITDA, EV/FCF, P/E, and P/S.
1. PepsiCo's stock is overvalued relative to the firm's growth potential. Analysts in average predict PepsiCo's revenues, EBITDA, and EPS to rise by 2-year CAGRs of 1.8%, 0.5%, and 4.9% over the current and next fiscal years. The rates are significantly slower that the peer averages of 4.9%, 6.6%, and 9.0%. Accounting for PepsiCo's lackluster earnings growth, the stock trades at a PEG of 3.2x, substantially above the peer average of 2.0x (see above).
2. PepsiCo's stock is also somewhat overvalued relative to the firm's other fundamentals. PepsiCo's profitability is fairly in line with the peer averages. Although the firm has a higher LTM gross margin, its EBITDA, EBIT, and net profit margins are marginally lower than the averages. Both the ROE and ROIC are only slightly above than the peer group's. On the liquidity side, PEP's LTM FCF margin is very similar to the group average. Despite being more leveraged, PEP's interest coverage ratio is in line with the averages. The current and quick ratios are also at the average level (see above).
Overall on the fundamentals, PepsiCo underperforms significantly in future growth and has mediocre profitability and liquidity conditions relative to the peer group. As such, it would be reasonable for the stock to trade at a slight discount to the peers. Nonetheless, the current stock price of $73.15 implies an average of 4.1% valuation premium over the five peer-average trading multiples (see below).
3. PEP stock's forward P/E multiple has been trending up over the past 12 months (see below). However, the company's financial estimates have experienced multiple downward revisions over the same period (see below), suggesting the stock has become more expensive.
4. According to Thomson One, the mean target price for PepsiCo is only $74.54, 2% above the current stock price, implying a further upside could be very limited.
5. Despite the aforementioned negativity, I do like PEP's 2.9% dividend yield. PepsiCo's management has a strong commitment to the dividend policy, as annual dividend per share has been raised to $2.03 in FY2011 from $0.58 in FY2001 by a steady 10-year CAGR of 13.4% (see below). The trend of continued dividend increase also appears sustainable. The chart below shows that PepsiCo's annual FCF has been steadily improving over the last decade, and the annual dividend payment in average represent only a bit more than half of the annual FCF generated in the recent years, suggesting that there remains a large room for dividend improvement down the road.
Bottom line, PepsiCo's stock starts to look overvalued as it reaches the 52-week high. Since I still like the firm's diversified product portfolio, its strong global presence, and healthy financials, I would feel more comfortable buying the shares at a price below $70. As such, I recommend a hold rating for the stock. If you'd like to establish a long position now, selling out-of-money puts would be a wise option.
Comparable analysis and relative valuation tables are created by author, other charts are sourced from Capital IQ, and all financial data is sourced from Morningstar, Thomson One, and Capital IQ.