PepsiCo: The End Of An Era
Summary
- PepsiCo's revenues have been close to flat over the last decade but have improved in the last few years.
- In its search for growth, the company has been disregarding profitability.
- Higher prices with worse fundamentals make this a riskier investment than you might think.
Thesis Summary
PepsiCo (NASDAQ:PEP) is a household name offering a variety of consumer goods in the beverage and food sector. Despite little growth over the last 10 years, the company trades at a premium due to its recent performance. However, I don't expect this to continue. Pepsi does not offer a unique value proposition and has been losing profitability for a long time. With over ⅔ of revenue coming from the U.S. and a few retailers, the company is exposed to things out of its control.
Source: Blizzardwatch.com
Recent Performance
Pepsi sells and commercializes some of the best-known snack and beverage brands in the world. The company is responsible for Lays, Ruffles, Tropicana, and Quaker Oats. Due to the nature of its products, Pepsi is one of the few companies that have enjoyed a slight tailwind from the coronavirus due to people stockpiling drinks and food. Indeed, the company has had a decent quarter with revenues up by around $1 billion compared to the same quarter last year.
Source: 10-Q
Growth has been especially good overseas, with the company reporting 14% revenue growth for its European region. However, domestically it has been much less impressive, and the numbers look even worse when we begin to look at profitability. Furthermore, the company seems to be expanding aggressively, adding over $7 billion to its liabilities in the last year. This leaves me wondering whether Pepsi can sustain the recent levels of growth it has achieved over the next few years. And if so; at what price?
Growth or Profitability
While growth is important to investors, profitability and cash-making ability is certainly the biggest appeal with Pepsi. The company is a dividend king and currently offers a reasonable 3% dividend yield with an impressive track record of dividend growth.
But this could all be put into question if Pepsi doesn't manage to turn around what seems to be an ongoing issue of profitability. The table below shows a breakdown of revenues and Operating Profit by segment in the first quarter of 2020 and 2019.
Source: 10-Q
First, and most striking is the fact that PepsiCo Beverages, the segment producing the most revenue, ($4.8 billion) is only contributing $297 million in operating profit. To "compensate" for this, we have Frito-Lay North America, the second-largest segment which turns around 1/4 of its revenues into operating profits. Frito-Lay accounts for over 60% of operating profits.
The latest quarter is representative of what has been happening at Pepsi over the last 3 years. While revenues have grown consistently around 2-4%, operating profits have stayed flat.
Source: 10-Q
Looking more closely at the income statement, we can see that SGA and Cost of Sales have slightly outpaced the growth of revenues. Another interesting fact is that "Other Pension and Retiree Medical benefits" was adding around 200-300 million to profits in 2017-2018 but in 2019 this became an expense. Looking at EPS the company seemed to have a very good 2018, but again we can see this has little to do with operating profit and more to do with the provision for taxes. If we look at Income before taxes, Pepsi is down around 3% since 2017.
Lastly, going further back, we have the EBITDA margin for the last 10 years:
Source: Seeking Alpha
Again, the trend is very clear and if it continues like this, the company's dividend could even be put into question.
Not as "safe" as you think
The issue of profitability could weigh on Pepsi, but there is no doubt that as long as a semblance of normalcy continues, Pepsi will continue to pay out its dividend. But what if things change? One thing I always look into is where revenues come from and how diversified these revenues are. In the case of Pepsi, unfortunately, revenues are concentrated which could mean things could quickly turn south if the right factors come into play.
Most notably, if we look at the latest quarterly report, over 85% of revenues came from North America. This surprised me at first, as I thought Pepsi was a lot more prevalent worldwide, and especially in Europe. From a macroeconomic standpoint, Pepsi's future is tied to that of the American economy and would suffer greatly in a recession. Firstly, because people would have less disposable income, but most importantly because Pepsi's products carry a premium over other cheaper store brands and consumers could easily choose to switch from one to the other.
But here's the kicker. According to marketrealist, in 2018 PepsiCo's top five retail customers accounted for 33% of the North America revenue. Walmart alone accounted for 19% of revenues. This means we have revenues concentrated into one area, a few products, and only a bunch of retailers. So what would happen if Walmart no longer wanted to sell Pepsi? More realistically, what would happen to sales if Pepsi didn't have a premium placement in these stores? While this shouldn't change any time soon, the point is that Pepsi's sales are in a way out of their control
Lastly, it's also worth mentioning the age-old argument; Pepsi's products aren't exactly healthy and people are moving away from these. I got a lot of heat from arguing this in my recent article on The Coca-Cola Company (KO). However, this still applies to soft drinks and even more to snacks like chips which have close to zero nutritional value.
Takeaway
You may think that I am being overly harsh on Pepsi but one must be when looking at a company with such a long history and reputation. Many investors might be happy to invest in this company thinking it doesn't involve much risk and this isn't true. In the short-term, the dividend seems safe, but the stock price could come down from here. Pepsi is now trading at a very high P/E when compared to some of its peers. Pepsi is priced very similarly to McDonald's Corporation (MCD) which I have also been critical of. I just hope that Pepsi's search for growth doesn't continue to hurt its profitability.
This article was written by
I am an economist and financial writer specialising in building robust and truly diversified portfolios that will preserve and increase wealth in the long term.
Having been born in Spain, to an English family, with extensive work experience in the US, and now living and travelling across Latin America and Asia, I believe this gives me a unique understanding of the global economy.
Only by investing in multiple assets around the globe can investors be truly diversified and protected from the ever-present risks posed by economic cycles and geopolitics.
My Links:
Investing Group: https://seekingalpha.com/checkout?service_id=mp_1401
Youtube: https://www.youtube.com/channel/UCUNZ28Ydsumo0P8FZ9OtquA
Podcast: https://open.spotify.com/show/7JVmqZUVhe1vvgDCstNBBJ
Substack: https://jamesfoord.substack.com/
Analyst’s 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (103)
You can sell your shares. I'll buy it from you. 😁 People don't buy chips and a cold drink because of ideology. They buy it because it tastes good to them and they want a snack. Also...what you said about being dependent on the US for revenue may be true...for now. All that means is---OMG 😵 they have an entire world to grow into...imagine the time when Pepsi successfully branches out!!!
I hope it continues into the future and increases as more people around the world get exposed to it. I don't see why it wouldn't.
A product in high demand.
Dividends keep coming and get reinvested. I'm not ready to sell it yet.
CAG: 24% (2019 annual report)
KHC: 21% (2019)
CPB: 20% (2019)
GIS: 20% (2019); was almost 10% higher before Blue Buffalo pet food acquisition
