- As global markets are tanking due to the coronavirus, I am once again looking for interesting dividend stocks.
- Pepsico is offering a solid and rising dividend yield, increasing buybacks and a satisfying balance sheet on top of solid organic sales growth.
- I hope to buy as soon as the stock is down 10% and will add on further weakness.
This is the first time I am covering the Purchase NY based consumer staples giant Pepsico (NASDAQ:PEP) on this website. The reason I am writing this article is the current stock market environment. Global stocks are heavily impacted by the ongoing coronavirus and its implications on established supply chains. This once again warrants the search for excellent stocks that are trading at a discount. Pepsico is one of these stocks. The company has an excellent business track record, a long history of increasing shareholder value, a stable balance sheet. And above all: with global yields in a free fall, there is an increasing need to buy yield.
Normally, this is the part where I explain what a company does for people who are new to a certain company. However, as Pepsico is the world's second-largest producer of beverages with a market cap of $191 billion and more than 265,000 employees, I am keeping the descriptive part a bit small and focus on the pros that make this company a good company a bit more.
Let's start by mentioning some of the 'basics'. First of all, Pepsico's products include its flagship beverage Pepsi and well-known brands like Tropicana, Gatorade, Mountain Dew, 7Up, and Lipton. The company also owns brands like Quaker, Sodastream, Lay's Chips, Cheetos and Brisk. To give you a few numbers, 54% of the company's sales are generated in its snacks segment. In this segment, the company has the world's largest market share. Beverages, which account for 46% of sales provide the company with the second biggest market share - right behind its biggest competitor Coca-Cola (KO). To date, 58% of sales are generated in the US. 71% of sales are generated in developed markets. The remaining 29% come from emerging markets with Mexico being the biggest market in that segment with 6% of total sales. With 75% of total sales being generated in five countries, there is a clear objective to further benefit from a rising population and a growing middle-class in emerging market countries.
The company's vision can be seen below, which basically is to become a global leader in convenient foods and beverages by winning with purpose. The last part seems to be open to interpretation, but the message is clear: become bigger.
In this case, Pepsico's growth approach is based on three pillars: faster, stronger, and better. Faster, is aimed at efficient advertising and marketing, faster transportation routes and an efficient supply chain. Stronger is aimed at the company's capabilities, costs, and business culture. Better covers company activities to enhance sustainability like a declining use of water and better packaging solutions.
With all of this being said, the company's results are good. While 2019 was a challenging year with global economic indicators in a steep decline, the company managed to achieve organic revenue growth of 4.5%. Since the recession, total sales growth has only been negative in two years (2012 & 2015). However, keep in mind that total sales growth is highly impacted by acquisitions and divestitures.
On a full-year 2020 basis, management expects organic sales growth to continue at 4%. EPS adjusted for currency fluctuations is expected to rise by 7%. The same growth rate is expected to apply to total dividends growth in 2020.
Pepsico, Please Pay Me
And speaking of dividends, the graph below shows the long-term development of dividends per share and shares outstanding. Total dividends paid per share have more than doubled since 2010 implying an annual growth rate of more than 10%. That's 800 basis points above the target inflation rate of 2%. Meanwhile, the company has cut the number of shares outstanding from $1.8 billion in the early 2000s to currently $1.40 billion.
At this point, I wanted to write that buybacks are increasingly important to the company. However, that's not exactly the case here as BOTH dividends and buybacks are rapidly increasing. In 2019, the company paid dividends worth $5.3 billion. That's 7.6% more compared to the 2018 fiscal year. The amount spent on buybacks was up 50% to $3.0 billion. Note that both numbers are negative as this is a negative value on the cash flow statement (cash is leaving the company).
Source: Author's Spreadsheets (Raw Data: SEC)
You probably guessed it already, but a 19.8% payout hike in 2019 and 7.1% payout growth in 2018 is leading to a higher payout ratio. The table below shows the payout ratio of dividends and repurchases as a percentage of operating cash flow. Dividends are currently at 55.0% with repurchases rising 10 points to 31.1%.
Source: Author's Spreadsheets (Raw Data: SEC)
The graph below shows the long-term trend of the payout ratio. Note that this graph contains dividends only as buybacks are more volatile and easier to cut in situations where liquidity is needed. The payout ratio has steadily improved from 20% in the early 2000s to currently 55%. Note that despite this trend, the payout ratio is still sustainable.
Even when adding buybacks, free cash flow has been positive in most years. The 2019 decline is more of an outlier due to higher acquisition expenditures. I expect this trend to reverse and expect that both 2020 and 2021 will see positive net cash changes.
Adding to that, one of the key questions that arise when a stock price has tripled since the 2009 recession is how the dividend yield is holding up. Due to the ongoing dividend hikes, the company has offset all capital gains since the recession. Meaning all initial investors since 2009 bought into a stock yielding between 2.5% and 3.2% (approximately).
With that said, let's move over to the next part of this article.
Debt Levels & Valuation
Let's start by mentioning that Pepsico does not have the perfect balance sheet. The company has a current ratio of 0.86 - meaning that current assets cover 86% of current liabilities. This is down significantly from the prior year as the company has a current ratio of roughly 1.20 on average. This decline was solely caused by a decline in cash. Long-term debt as a percentage of equity was at 196%. This is pretty much unchanged from 194% in 2018 and the result of net assets rising along with total liabilities. The graph below shows this long-term development of total assets, total liabilities, and liquidity (current assets).
Overall, it is safe to say that the company (just like many other major conglomerates and dividend companies) is expanding using debt without rising financial stability.
Concerning the company's valuation, we are seeing long-term developments similar to the change in dividend yield. While the stock price has tripled since the recession, the price/earnings ratio has been kept from rising 'too fast'. The company is currently valued at 26.5x earnings. This is unchanged from 4 and 14 years ago. The market cap as a multiple of operating cash flow is currently at 19.7x. This is the highest level since the pre-recession years.
Normally, I would not too excited about a company trading at 19.7x free cash flow and 26.5x earnings. However, Pepsico is a stable company with a rising payout ratio and a lot of long-term potential left. This is exactly the kind of company you want when global rates are falling. In the past few weeks, the 10-year US government yield has dropped below 0.70%. Even the 30-year government bond yield is 70 basis points below the S&P 500 yield of roughly 2.0%. In this situation, it's not entirely appropriate to compare valuation levels to periods when rates were more than 200 basis points higher. It is, therefore, no surprise that the company is trading at 19.7x operating cash flow. It would even make sense if this ratio were to rise even further.
In situations, like we are currently witnessing, I want to own good yield. By 'good yield', I mean companies excluded that are offering a high yield due to suppressed stock prices. It also helps that coronavirus fears have pushed the stock down. I consider Pepsico a good buy once the stock is 10% below its all-time high. This has happened multiple times since the recession. Note that the company as displayed by portfolio 1 in the graph below has outperformed the S&P 500 during all major drawdowns since the company turned mature in the early 2000s.
I have absolutely no idea how bad the coronavirus is going to get. None. The only thing I can do is analyze virus data and wait for the impact on the market. However, what I can do is buy some of the best dividend stocks on the market at discount prices. Pepsico is one of these companies. The company's fundamentals are strong as its product portfolio is allowing for strong organic growth, rapidly rising free cash flow and strong dividend gains. I believe this company will be a great buy for years to come and I expect to start buying as soon as possible. If the stock drops 10% from its all-time high, I will buy into weakness. Even if the stock drops further, I won't complain as volatility is low and long-term potential will not be damaged by the coronavirus.
Let me know what you think!
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PEP over 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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