PepsiCo: Buy This Dividend Aristocrat For Income And 8% Forward Growth

|
About: PepsiCo Inc. (PEP), Includes: ABC, ADP, AMT, BA, DLR, EOS, HD, JNJ, LB, SLP
by: William Stamm

Summary

PepsiCo's dividends are above average at 3.5% and have been increased for 44 years in a row as a dividend aristocrat.

PepsiCo's three-year forward CAGR of 8% is good and will give you good growth with the increasingly growing world economy and population.

Earnings for PepsiCo last quarter (ending July) were good, with earnings beating estimate and higher earnings than last year, as well as increasing revenues that beat estimate.

PepsiCo (PEP), one of the largest manufacturer and distributor of snack food and beverages, is a buy for the dividend growth investor and total return investor. PepsiCo has steady growth and has plenty of cash, which it uses to buy bolt-on companies, increase the dividend each year and buy back shares. Even with an earnings beat in the last quarter, Mr. Market did not like it; I think this is an opportunity to buy a great defensive company. PEP is 0.5% of The Good Business Portfolio, my IRA portfolio of good business companies that are balanced among all styles of investing. I want to increase this position as I need more solid income producing companies but do not have cash available at present.

When I scanned the five-year chart, PepsiCo has a good chart going up and to the right in a steady, strong slope for four of the five years. It had a steady upslope until this year when a dip created a strong buying opportunity.

Chart PEP data by YCharts

Fundamentals of PepsiCo will be reviewed on the following topics below.

  • The Good Business Portfolio Guidelines
  • Total Return and Yearly Dividend
  • Last Quarter's Earnings
  • Company Business
  • Takeaways
  • Recent Portfolio Changes

I use a set of guidelines that I codified over the last few years to review the companies in The Good Business Portfolio (my portfolio) and other companies that I am taking a look at. For a complete set of the guidelines, please see my article, "The Good Business Portfolio: Update To Guidelines and July 2016 Performance Review". These guidelines provide me with a balanced portfolio of income, defensive, total return and growing companies that hopefully keeps me ahead of the Dow average.

Good Business Portfolio Guidelines

PepsiCo passes 10 of 11 Good Business Portfolio Guidelines, a good score (a good score is 10 or 11). These guidelines are only used to filter companies to be considered in the portfolio. Some of the points brought out by the guidelines are shown below.

  1. PepsiCo does meet my dividend guideline of having dividends increase for 8 of the last ten years and having a minimum of 1% yield, with 44 years of increasing dividends and a 3.5% yield. PepsiCo is, therefore, a good choice for the dividend growth investor. The payout ratio of dividends is moderate at 68%. After paying the dividend, this leaves cash remaining for investment in expanding the business by buying bolt-on companies, increasing the dividend and buying back shares.
  2. I have a capitalization guideline where the capitalization must be greater than $10 billion. PEP easily passes this guideline. PEP is a large-cap company with a capitalization of $152 billion. PepsiCo's 2018 projected cash flow at $10 billion is good, allowing the company to have the means for company growth and increasing the dividend.
  3. I also require the CAGR going forward to be able to cover my yearly expenses and my RMD with a CAGR of 7%. My dividends provide 3.2% of the portfolio income, and I need 1.9% more for a yearly expense distribution of 5.1%. The three-year forward CAGR of 8% exceeds my guideline requirement. This good future growth for PEP can continue its uptrend, benefiting from the continued strong growth in the worldwide economy.
  4. My total return guideline is that total return must be greater than the Dow's total return over my test period. PEP fails this guideline since the total return is 52.96%, less than the Dow's total return of 60.95%. Looking back five years, $10,000 invested five years ago would now be worth over $16,100 today. This makes PepsiCo a fair investment for the total return investor looking back, that has future growth as the world economy continues to grow.
  5. One of my guidelines is that the S&P CFRA rating must be three stars or better. PEP's S&P CFRA rating is five stars or strong buy with a target price to $129.0, passing the guideline. PEP's price is presently 15.2% below the target. PEP is under the target price at present and has a relatively average PE ratio of 19, making PEP a fair buy at this entry point with steady growth to continue.
  6. One of my guidelines is would I buy the whole company if I could. The answer is yes. The total return is fair, and an above average yield makes PEP a good business to own for dividend growth income and growth long term. The Good Business Portfolio likes to embrace all kinds of investment styles, but concentrates on buying businesses that can be understood, make a fair profit, invest profits back into the business and also generate a fair income stream. Most of all what makes PEP interesting is the potential long-term growth of the economy and population giving you an increasing dividend for the dividend growth investor with a company that has a feel-good product. Further expansion into foreign countries will drive the company growth.

Total Return and Yearly Dividend

The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. PepsiCo underperforms against the Dow baseline in my 57.0-month test compared to the Dow average. I chose the 57.0-month test period (starting January 1, 2014, and ending to date) because it includes the great year of 2017, and other years that had fair and bad performance. The fair total return of 52.96% makes PepsiCo a fair investment for the total return investor that also wants a steadily increasing income. PEP has an above average dividend yield of 3.5% and has had increases for 44 years, a dividend aristocrat, making PEP also a good choice for the dividend growth investor. The dividend was last increased in May 2018 to $0.927/Qtr. from $0.805/Qtr., or a 15% increase. The dividend is estimated to be increased to $1.05/Qtr. based on projected increasing earnings and present payout ratio.

Dow's 57.0-Month total return baseline is 60.95%

Company name

57 Month total return

The difference from DOW baseline

Quarterly dividend percentage

PepsiCo

52.96%

-7.99%

3.5%

Last Quarter's Earnings

For the last quarter on October 1, 2018, PepsiCo reported earnings that beat expected by $.02 at $1.59, compared to last year at $1.48. Total revenue was higher at $16.49 billion, more than a year ago by 1.5% year over year and beat expected revenue by $130 million. This was a good report with bottom line beating expected and the top line increasing with a good increase compared to last year. The next earnings report will be out January 2019 and is expected to be $1.49 compared to last year at $1.31, a good increase.

Business Overview

PepsiCo is one of the largest manufacturers and distributors of snack food and beverages in the United States and foreign countries.

As per excepts from Reuters:

"PepsiCo, Inc. is a global food and beverage company. The Company's portfolio of brands includes Frito-Lay, Gatorade, Pepsi-Cola, Quaker, and Tropicana. The Company operates through six segments: Frito-Lay North America (FLNA), Quaker Foods North America (QFNA), North America Beverages (NAB), Latin America, Europe Sub-Saharan Africa (ESSA), and Asia, Middle East and North Africa (AMENA). The FLNA segment includes its branded food and snack businesses in the United States and Canada. The QFNA segment includes its cereal, rice, pasta and other branded food businesses in the United States and Canada. The NAB segment includes its beverage businesses in the United States and Canada. The ESSA segment includes its beverage, food and snack businesses in Europe and Sub-Saharan Africa. The AMENA segment includes its beverage, food and snack businesses in Asia, Middle East, and North Africa."

Overall, PepsiCo is a great business with 8% CAGR projected growth as the worldwide economy grows going forward with increasing demand for PEP's products. The good earnings and revenue growth provides PEP the capability to continue its growth as the business increases by buying bolt-on companies and foreign expansion.

The graphic below shows some of the great brands the company sells or has an agreement to sell other companies' products.

Source: PepsiCo web site

The Fed has kept interest rates low for some years, and on September 26, they raised the base rate by 0.25%, which was expected. I believe that they will not raise the rates anymore this year, but will go slow the rest of 2018, which should help keep the economy on a growth path. If infrastructure spending can be increased, this will even increase the United States' growth going forward with better economics for the consumer.

From October 1, 2018, earnings release, Indra Nooyi (Chief Executive Officer, Chairman) said:

"For the quarter we generated $16.5 billion of net revenue driven by 4.9% organic revenue growth and delivered core earnings per share of $1.59, a 9% increase on a core constant currency basis. Overall, we are pleased with our operating and financial performance in the quarter.

The organic revenue growth represents another quarter of sequential acceleration and the highest rate of organic revenue growth in 12 quarters. The majority of our businesses again perform well, but particularly strong performances by our international sectors and a solid performance by Frito-Lay in North America.

And while North American beverages profit performance was impacted by inflation and a double-digit increase in advertising expense, the sector posted 2.5% organic revenue growth with a good balance between volume growth and net price realization.

Frito-Lay North America delivered balanced volume growth and net price realization driving by strong innovation and brand marketing. For example, in June we launched Stacy's Cheese Petites inspired by French Cheese Puff, these bite-sized cheese snacks have real cheese baked inside creating a sophisticated snacking experience.

Cheese is the primary ingredient. Petites are a good source of calcium and have six grams of protein per serving, and they come in a resealable pouch making them great for a convenient on-the-go experience.

In the midst of managing the business for the long-term, we also delivered strong and consistent financial performance specifically during the period 2006 to 2017. Net revenue grew more than 80%. We added a new billion dollar brand almost every other year. We returned $79 billion to shareholders through dividends and share repurchases. Our market capitalization increased by $68 billion. Dividends per share nearly tripled from $1.16 to $3.17, and we generated a total shareholder return of 162%.”

This shows the feelings of top management for the continued growth of PepsiCo's business and shareholder return with an increase in future growth. PEP has good constant growth and will continue as the world economy grows. Indra Nooyi leaves the company in good hands, and she should be proud of the growth of the business under her leadership.

Takeaways

PepsiCo is a good investment choice for the dividend growth investor with its above average dividend yield and a fair choice for the total return investor. PepsiCo is 0.5% of The Good Business Portfolio, and the position will be increased when cash is available. If you want a steady growing dividend income and good total return, PEP may be the right investment for you.

Recent Portfolio Changes

I intend to watch the earnings reports for the companies in the portfolio and may finally decide to trim my high flyers that are over 8% of the portfolio.

  • On August 22, increased the percentage of Digital Realty Trust (NYSE:DLR) to 3.3% of the portfolio. I want to get this REIT to a full position of 4%.
  • On August 15, sold all remaining AmerisourceBergen (ABC) in the portfolio.
  • On August 9, reduced AmerisourceBergen to 0.4% of the portfolio. I will most likely sell the remainder of ABC next week. The company margin is very thin, and I don't like the present pressure of the opioid crisis. The risk has gotten too high versus the reward.
  • On July 12th, bought a small starter position (0.1% of the portfolio) in Simulations Plus (SLP), a small software company that helps test/simulate new drugs before they are released. SLP is a very speculative investment and should be watched carefully.
  • On June 20th, closed out covered calls and sold Kraft (NASDAQ:KHC) position, I needed some cash. I got a better price using the calls but missed some of the recent gains.
  • On June 8th, sold KHC July 57.5 calls against the position and will make 4% if the KHC price remains the same. The calls are now in the money, and I may move them up and out when the time value is small.
  • On May 14th, I trimmed the position of Eaton Vance Enhanced Equity Income Fund II (EOS) from 9.2% of the portfolio to 8.9%. I still like EOS and don't want to overweight this fund which is high in technology companies.
  • On March 29, increased position of American Tower (AMT) to 0.8% of the portfolio. I will continue adding to this position as cash is available.
  • On March 29, sold entire position of L Brands (LB). It does not look good for the company going forward.

The Good Business Portfolio trims a position when it gets above 8% of the portfolio. The four top companies in the portfolio are, Johnson & Johnson (JNJ) at 8.1% of the portfolio, Eaton Vance Enhanced Equity Income Fund II at 8.4% of the portfolio, Home Depot (HD) at 10.2% of the portfolio and Boeing (BA) at 14.2% of the portfolio. Therefore, BA, EOS, JNJ, and Home Depot are now in trim position, but I am letting them run a bit since they are great companies.

Boeing is going to be pressed to 14% of the portfolio because of it being cash positive on 787 deferred plane costs at $316 million in the first quarter of 2017, an increase from the fourth quarter. The second quarter saw deferred costs on the 787 go down $530 million, a big jump from the first quarter. The second quarter of 2017 earnings was fantastic, with Boeing beating the estimate by $0.25 at $2.55. The third quarter of 2017 earnings were $2.72, beating the expected by $0.06, with revenue increasing 1.7% year over year, another good report. The first-quarter earnings for 2018 were unbelievable at $3.64 compared to expected at $2.64. Farnborough Air Show sales in dollar value just beat out Airbus (OTCPK:EADSY) by about $6 billion, and both companies had a great number of orders. The second-quarter earnings beat expectations by $0.06 at $3.33, but a good report was hurt by a write off expense on the KC-46 which should start delivery in October of 2018. Boeing recently got an order for 18 more KC-46A planes.

JNJ will be pressed to 9% of the portfolio because it's so defensive in this post-BREXIT world. Earnings in the last quarter beat on the top and bottom lines and Mr. Market did like it. JNJ has announced a dividend increase to $0.90/Qtr. which is 56 years in a row of increases. JNJ is not a trading stock but a hold forever; it is now a strong buy as the healthcare sector remains under pressure.

For the total Good Business Portfolio, please see my article on The Good Business Portfolio: 2018 2nd Quarter Earnings and Performance Review for the complete portfolio list and performance. Become a real-time follower, and you will get each quarter's performance after the next earnings season is over.

I have written individual articles on JNJ, EOS, GE, IR, MO, BA, PEP, PEP, PM, LB, Omega Health Investors, Digital Investors Trust and Automatic Data Processing (ADP) that are in The Good Business Portfolio and other companies being evaluated by the portfolio. If you have an interest, please look for them on my list of previous articles.

Of course, this is not a recommendation to buy or sell, and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account, and the opinions of the companies are my own.

Disclosure: I am/we are long BA, JNJ, HD, OHI, MO, IR, DLR, GE, PM, LB, MMM, ADP, PEP.

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.