PepsiCo's Stock Buybacks: A Mixed Record In Generating Value

| About: PepsiCo Inc. (PEP)

Summary

This article reviews PepsiCo’s stock buyback record to determine how the company has done in using stock buybacks to enhance value for shareholders.

This review shows that PepsiCo has done a mixed job in generating value for shareholders through its stock repurchase programs.

PepsiCo has repurchased stock when it was affordable for the company, but these repurchases only occurred when the stock was undervalued between 2010 and 2013.

Introduction

The purpose of the article is to consider the stock buyback record of PepsiCo (NYSE:PEP) in enhancing value for shareholders.

Stock buybacks, or repurchases of shares, should be good for shareholders. Stock buybacks should reduce the number of outstanding shares, and in doing so, should increase the ownership stake of shareholders. This should have a positive effect on a company’s return on assets, return on equity and earnings per share by reducing assets/outstanding equity.

However, the relationship between stock buybacks and shareholder value is often a bit more complicated than this. On the one hand, shareholder value is generated if the repurchase occurs when the stock is undervalued and represents the best possible investment for the company. On the other hand, stock buybacks can destroy value if the company is using stock buybacks to prop up financial ratios, give support to a falling stock price or reduce the dilutive impacts of employee stock option plans.

Criteria for assessing PepsiCo’s share buybacks

To assess the stock buyback record of PepsiCo in enhancing value for shareholders, I use two criteria: affordability and value for money. The reason for this is that shareholder value is created if repurchases are affordable and demonstrate value for money. This is why Warren Buffett uses affordability and value for money as the key conditions in deciding when to repurchase Berkshire Hathaway stock:

“Charlie and I favour repurchases when two conditions are met: first, a company has ample funds to take care of operational and liquidity needs of the business; second, its stock is selling at a material discount to the company’s intrinsic value.”

-
Chairman's Letter, Berkshire Hathaway Annual Report 2011

Affordability

I compare PepsiCo’s expenditure on stock buybacks to its free cash flow to determine affordability for the company of the expenditure spent on stock buybacks. Free cash flow is a useful metric for considering affordability of expenditure because it represents the cash available for investment after money spent on maintaining or increasing a company’s asset base.

Figure 1 shows that, for the most part, PepsiCo’s expenditure on stock buybacks has been affordable. In most years, the expenditure on repurchases has been lower, and often much lower, than free cash flow generated. However, it is debatable whether the expenditure on stock buybacks in 2008 was affordable. The reason for this is that PepsiCo spent $3.04 per share on repurchases in 2008, compared to only having $2.72 in free cash flow per share.

(Notes: Free cash flow is cash flow per share minus capital expenditure per share. Repurchase price for any year is the average repurchase price of all transactions in that year. Data taken from company 10-K, 10-Q and Yahoo Finance.)

Value for money

When a stock is undervalued compared to its intrinsic value, stock repurchases show value for money.

Determining undervaluation is not easy. For Berkshire Hathaway, Warren Buffett uses the metric of 110% of book value as a proxy for undervaluation. I also favour using systematic benchmarks as proxies for undervaluation, although the proxies I use are different.

I primarily judge undervaluation by comparing the repurchase price to an approximate cash value for the shares. To help confirm undervaluation, I also compare the trailing P/E ratio with the long-run P/E ratio.

I consider that fair value equals the cash value/long run P/E ratio. For there to be undervaluation, I consider it necessary for the repurchase price to show a reasonable discount to fair value. It is important to have a reasonable margin of error in any fair value calculation due to using rough proxies of value, cash value and the long-run P/E ratio.

Using this method, figures 2 and 3 show that PepsiCo has done a mixed job in generating shareholder value through buybacks.

The company did enhance shareholder value between 2010 and 2013 by repurchasing undervalued stock. In these years, stock was repurchased at a significant discount to both cash value and the long-run P/E ratio.

(Notes: No stock was repurchased in 2009. Repurchase price for any year is the average repurchase price of all transactions in that year. Data taken from company 10-K, 10-Q and Yahoo Finance.)

(Notes: No stock was repurchased in 2009. Data taken from company 10-K, 10-Q and Yahoo Finance.)

However, most years, PepsiCo repurchased stock when it was not undervalued.

There are also a couple of other issues with the way the company managed its stock buybacks.

First, in 2009, PepsiCo passed up a gilt edged opportunity to repurchase its stock when it was undervalued. During this time, the stock was trading at a significant discount to its fair value. PepsiCo could have comfortably made stock repurchases this year because they had been authorised and were affordable. In 2009, the company still had approximately $6.4 billion to spend of the $8 billion 2007 stock repurchase program, which did not expire until 2010. Purchasing stock during 2009 would have clearly been affordable as well. Figure 1 showed a healthy free cash flow during the year. PepsiCo used this healthy free cash flow to increase its dividend 6% in this period. Despite all of these factors in favour of repurchasing stock in 2009, the company made no repurchases.

Second, the value of repurchases when PepsiCo stock was undervalued has typically been much less than repurchases at other times (see Figure 1). On average, the company has spent $2.93 per share on repurchasing stock in years when it was not undervalued, compared to only $2.20 per share in years when it was undervalued. On a more positive note, PepsiCo has done a better job for shareholders in 2016. At a time when its repurchase price was above fair value, the company significantly reduced its repurchasing of shares compared to 2015 and 2014 levels.

PepsiCo has also done a decent job in executing its repurchases at the best market price. This can be judged by comparing its average annual repurchase price to the median daily closing price for repurchase years. As Figure 4 shows, the company’s average annual repurchase price closely matched the median daily closing price for most years.

(Notes: No stock was repurchased in 2009. Data taken from company 10-K, 10-Q and Yahoo Finance.)

Conclusion

PepsiCo has done a mixed job in generating value for shareholders through its stock repurchase programs.

It has repurchased stock when it was affordable for the company, but these repurchases only occurred when the stock was undervalued between 2010 and 2013. More often than not, PepsiCo has repurchased stock when it was not undervalued. Moreover, expenditure on repurchases was far greater when the stock was not undervalued than when it was undervalued. This is perhaps because affordability has been more important than value for money in driving repurchases.

To put these results in context, I have written two companion articles on the stock buyback record of key PepsiCo competitors Coca-Cola (NYSE:KO) (Coca-Cola's Stock Buybacks: A Warning For Potential Investors) and Dr Pepper Snapple (NYSE:DPS) (Dr Pepper Snapple's Stock Buybacks: A Record Of Generating Value). This shows that PepsiCo’s repurchases did not add as much shareholder value as Dr Pepper Snapple but were significantly better in adding value than Coca-Cola.

Considering the results of the repurchase schemes of all three companies reviewed, some general trends can be inferred about company repurchase schemes in generating shareholder value:

  • Affordability seems to be the driving force behind repurchase schemes.
  • Value for money does not seem to be a critical factor driving decisions to repurchase shares. For all three companies, we see repurchases occurring at times when there is no value for money. Moreover, the amounts spent on repurchasing shares are often greater when there are higher profits, irrespective of value.
  • Some companies execute their repurchase programs better than others.
  • Investors should be cautious when companies are repurchasing shares above fair value. Future investors in PepsiCo should perhaps be cautious. Apart from 2016, the last time the company was repurchasing stock above fair value was in 2008.
  • A good time to buy shares is when companies are repurchasing shares at levels significantly below fair value.

Disclosure: I/we 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.

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