PepsiCo - Premium Valuation For Collection Of Premium Brands

| About: PepsiCo Inc. (PEP)
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Shares of PepsiCo (NYSE:PEP) jumped up on Wednesday after the company reported solid third-quarter results. Despite the solid performance, I remain on the sidelines.

While I like the diversified operations of the firm and the strong brands, accompanied by high shareholders payouts, I am cautious given the premium valuation and reasonable high debt position.

Third-Quarter Results

PepsiCo generated third-quarter revenues of $16.91 billion, up 1.5% on the year before. Organic revenues rose by 3.3% for the quarter. Analysts were looking for revenues in between $16.9 and $17.0 billion for the quarter.

Note that operating earnings fell by a percent to $2.78 billion, but PepsiCo benefited from lower taxes, which resulted in a 1% increase in net income, totaling $1.91 billion.

GAAP earnings rose by two pennies to $1.23 per share. Note that "core" earnings came in a penny higher, comfortably beating consensus estimates of $1.17 per share. CEO and Chairman Indra Nooyi commented on the third quarter performance:

We're pleased with our performance. PepsiCo has delivered double-digit core constant currency earnings per share growth year to date, despite ongoing macro-economic volatility in many markets. We're able to perform well in these conditions because our brands are strong, our product portfolio is on-trend, and our geographic footprint is broad and diverse.

Looking Into The Results

While PepsiCo reported organic revenue growth of 3.3%, reported net revenue growth of 1.5% came in lower due to the re-franchising of beverage operations in Vietnam and adverse foreign currency moments.

Gross margins rose by 5 basis points to 53.0% in the third quarter, coming in practically unchanged. Note that selling, general and administrative expenses rose relatively sharply, and were up by 44 basis points to 36.4% of total revenues.

As a result, operating earnings fell by 37 basis points to 16.4% of total revenues, while net earnings saw a very modest boost from absolute revenue growth and lower taxes.

The company performed relatively well in its Food segment within the Americas, where it reported a 5% jump in revenues to $6.08 billion, driven by the Frito-Lay and Latin American operations.

PepsiCo saw a relative poor performance of the American Beverage unit, which reported a 2% drop in revenues to $5.40 billion. Europe performed relatively well on strong pricing while the Asian, Middle East and African activities reported a modest fall in revenues. Note that organic growth rates came in at 6% in that region, offset by currency translation and divestitures.


PepsiCo is reiterating its previous outlook for 7% core constant currency earnings per share growth, compared with last year's $4.10 per share. Yet currency headwinds are expected to shave off 2% earnings growth from this projection.

Organic revenues are expected to grow in the mid-single digits, excluding the impact of structural changes and adverse currency movements, which combined provide an estimated 3% drag on revenue growth.


PepsiCo ended its third quarter with $9.6 billion in cash, equivalents and short-term investments. Total debt stands at $29.5 billion, for a net debt position of around $20 billion.

Revenues for the first nine months of the year came in at $46.3 billion, up 2% on the year before. Net earnings rose by 11% to $5.0 billion. At this pace, PepsiCo is on track to generate revenues around $66.5 billion, as core earnings are seen around $6.5 billion.

Trading around $82 per share, the market values PepsiCo at roughly $126 billion. This values operating assets at 1.9 times annual revenues and 19-20 times annual earnings

PepsiCo currently pays a quarterly dividend of $0.5675 per share, for an annual dividend yield of 2.8%.

Some Historical Perspective

Long-term holders in PepsiCo have seen decent returns. Shares steadily rose from $50 in 2004 to a high approaching $80 by 2007. After shares had fallen back to lows of $50 during the financial crisis again, they steadily rose to highs of $87 earlier this year, after which they have seen a modest 5% pullback.

Between 2009 and 2012, PepsiCo has increased its annual revenues by a cumulative e 51% to $65.5 billion. Note that earnings have been reasonably stagnant, increasing by merely 4% over the time period to $6.2 billion.

Investment Thesis

So far this year, shares of PepsiCo have already risen some 20%, partially driven by activist pressure from Nelson Peltz who earlier this year urged that PepsiCo should buy cookie maker Mondelez International (NASDAQ:MDLZ), prompting its shares to trade with year-to-date gains of 25%.

While PepsiCo continues to struggle with its beverage businesses, as it reported a 4% sales volume decline, the snack business performs really well with Frito-Lay reporting organic growth rates of 7%. This gives executives at PepsiCo some ammunition to fend off activist shareholders. Under the plan of Peltz, PepsiCo could spin-off the beverage unit and acquire Mondelez to focus more on crackers and snacks, but PepsiCo's executives are not really a fan of the plan.

They plan is to stick to the diversified food and beverage operations, now having 22 brands with $1 billion or more in annual sales. Rather than breaking up the business, management is more focused on brand building, innovation, execution and improved productivity.

For now PepsiCo's management seems to be right after shares have posted solid returns this year. The firm furthermore stands to pay out $3.4 billion in dividends and another $3 billion in share repurchases this year, for combined cash flows of 5% to its shareholders.

While these combined payouts represent a near 100% payout ratio compared to earnings, PepsiCo is making progress targeting further productivity savings going forward.

It has been almost a year ago when I last took a look at PepsiCo's prospects. At the time shares were trading around $70 per share, and shares have nearly risen some 20% since that time. At the time I was quite cautious given the sizable debt position and lack of operating earnings growth. However, activists pressure and the high yield to shareholders at the time, combined with operational improvements, have pushed the stock higher over the past year.

At these levels I remain cautious. No need for me to pick up shares at these levels, even tough PepsiCo is a quality name. The diversified brands, solid cash flows to investors and steady growth profile are key strengths. Yet the reasonable debt position and the premium earnings multiple make me a bit hesitant to invest at the moment.

I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.