Pepsi: Should You Be Buying This Turnaround Story?

| About: PepsiCo Inc. (PEP)
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The global soft drink market is mostly dominated by just two players: PepsiCo (NYSE:PEP) and The Coca-Cola Company (NYSE:KO). As a consumer, we always have to make a choice between Coke and Pepsi in a grocery store. Investors also face a similar but a much more difficult choice in deciding which stock to go for. Both these beverage stocks have provided shareholders good returns over the past three decades and still continue to offer low-risk investment opportunities (as evident from the low beta of these companies; Coca-Cola has a beta of 0.41 and PepsiCo has a beta of 0.33).

Both PepsiCo and Coca-Cola recently reported their Q3 earnings (click here for Coca-Cola's earnings and here for Pepsi's earnings). From the earnings results, we can figure out that Coca-Cola is better positioned in the market with respect to PepsiCo as the company was able to pass on the commodity price increases to consumers. Coca-Cola reported volume growth of 4% in Q3 as compared to PepsiCo's volume growth to just 1%. Going forward commodity prices are expected to continue their upward trend and I think Coca-Cola's ability to pass on the price increases to consumers makes the stock much more attractive than PepsiCo. Let's analyze some key metrics like expected growth rate, forward dividend yield and debt/equity ratio of these two beverage giants.




Next 5 Year Growth



Dividend Yield



Debt/Equity Ratio



Source: Yahoo Finance

We can see that PepsiCo scores over Coca-Cola in terms of dividend yield. However, Coca-Cola has a far better expected growth rate and lower debt level as compared to PepsiCo. I believe PepsiCo is taking the necessary steps to turn around its business, but a marked improvement will take some time.

Innovation remains a pillar of PepsiCo's turnaround strategy. The company has made good progress on this front as the new products now account for 8% of sales. Moreover, the company hinted that further innovations were in the pipeline for 2013 and beyond, especially for its Gatorade brand and its soft drink portfolio. It is encouraging to see that PepsiCo is focusing on innovation and marketing, but still a lot more work needs be done and a meaningful turnaround will require considerable time.

Going forward, PepsiCo will likely reinvest any over-delivery (earnings beat) into greater marketing and advertising. PepsiCo's marketing expenses increased by ~12% in 3Q12 and should step up significantly in 4Q12 as the company will lap A&M cuts made in 4Q11. Importantly, management remains committed to its goal to spend 5.7% of sales on A&M and, I think, will likely step up this spend further next year. As reinvestment needs persist, I believe the stock's performance will continue to depend on multiple expansion and increasing investor confidence. In order to analyze the scope for multiple expansion in PepsiCo's stock, let's have a look at the valuation multiples (forward P/E and PEG ratio) of PepsiCo and its peer group including Coca Cola, Dr Pepper Snapple Group (NYSE:DPS) and Monster Beverage (NASDAQ:MNST).


Dr Pepper




Forward P/E





PEG Ratio





Source: Yahoo Finance

Accounting for PepsiCo's earnings growth prospects, the stock is trading at a PEG ratio of 3.76 and looks overvalued with respect to Coca-Cola, Dr Pepper as well as Monster Beverage. Income investors should look at Dr Pepper as it is a cheaper way to park your cash and get a similar dividend yield (3.10%). Monster also looks attractively priced relative to the company's strong growth prospects. Though Monster faces some regulation issues, its strong positioning in the rapidly growing energy drinks market and strong balance sheet makes me bullish on the stock. As far as PepsiCo is concerned, I don't see much scope for multiple expansion as the company is already trading at a significant premium to its peers on a growth adjusted basis.

To conclude, PepsiCo is showing some signs of improvement broadly across its domestic and international businesses but a marked improvement will take some time. The company is likely to reinvest any earnings beat into marketing and advertisement and thus, the stock's performance will depend on multiple expansion and increasing investor confidence. However, I see a limited upside potential in the near-term as the stock looks expensive on a PEG basis. I believe investors should wait for more visibility into the execution of plans and suggest avoiding this stock for the time being.

Disclosure: I 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.