PepsiCo: Model Reveals Outsized Returns Are Here To Stay

| About: PepsiCo Inc. (PEP)
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Summary

PepsiCo continues to beat analyst expectations quarter upon quarter.

Emerging markets to continue adding growth angle.

Pepsi True campaign goes awry; however, impact likely muted.

Levered returns illustrates a fair value estimate of approximately $114 – a 16% premium to PEP’s December 3rd closing price.

PepsiCo Continues to Dazzle

Armed with solid fundamentals, PespsiCo (NYSE:PEP) continues to beat analyst expectations quarter after quarter. The company has a number of strengths, such as strong distributor relationships as well as synergistic vertical integration; firm foothold in emerging markets, and a strong snacks business both locally and internationally that already contributes half of the company's topline. Analyzing the stock through the Levered Returns model, we were not surprised to find that it is trading at a 16% discount to its market price as of December 3 (you can see the Levered Returns model below).

Strong Emerging Market Support

Despite a challenging local market, where a move towards healthier drinks is proving a challenge for PepsiCo, and its rival Coca Cola (NYSE:KO), the emerging market growth story is still strong. In fact, as reported by Forbes, emerging markets continue to drive profits at the conglomerate.

Pepsi True Mishap Insignificant

PepsiCo continues to get hit now and then through a failed consumer health project. Its recent most foray into healthier drinks, 'Pepsi True' was taken off Amazon's website after an attack by environmentalists who targeted the product's page, bombarding it with bad reviews. The detractors claimed that the company failed to live up to its promise of using only sustainable palm oil in its products. We have left out this mishap from our model, as we believe it is only temporary and is likely not going to affect the operations of the company.

Levered Returns Valuation Model

We have assumed a rather conservative long term revenue growth rate of 3% in our model given a compounded annual growth rate "CAGR" of approximately 8.5% for the last ten years. Assuming a higher growth rate (you can change the growth rate in the model below) will obviously result in increased upside. Long term EBITDA margins have been assumed at 20%, slightly higher than the 19.5% expected for 2014. These revenue and profitability assumptions result in the company having an enterprise value of $189 billion. However given some debt on the company's balance sheet, the equity value comes lower, at $171 billion resulting in a per share fair value of $114 giving us an upside 16%:

Other Key Assumptions

Capital Expenditures: We have assumed capital expenditures to be 4.25% of revenues, in line with analyst projections.

Working Capital: Net working capital for the company has been negligible. To be conservative, we have assumed 1.0% (adjustable in the model above).

Discount Rate: To estimate the discount rate for PepsiCo, I used the Levered Returns discount rate model which you can assess below:

Conclusion

PepsiCo is a company that continues to surprise the street with its quarterly results. The reason is strong fundamentals and a clear-cut growth story. Factoring these assumptions into the model reveals an upside of 16% over its December 3rd closing price. The model is interactive and allows you to change the numbers to come up with your own fair value. For instance, if you feel the company's foothold in emerging markets permits a higher growth rate, be sure to change it and see the impact on the company's fair value!

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.