Brand-wise, PepsiCo, Inc. (NYSE: PEP) is a snack lover’s paradise. It’s a food and beverage company fit for a picnic, barbecue or a football tailgate party.
Pepsi’s complementary portfolio of brands include snack-time hall-of-famers like Frito-Lay, Gatorade, Pepsi-Cola and Tropicana. But the stock definitely lacks fizz these days, hovering around $114 with a one-year consensus analyst stock price of $117.
PEP stock at a glance. PepsiCo has been on a roller-coaster ride in 2018. PEP launched the new year with a share price of $115, but the stock price dropped to $94 per-share in late April, before climbing back to $114 in August.
Earlier this year, PepsiCo increased its dividend by 15 percent and shares now yield a respectable 3.3 percent at its current price. The stock currently trades at 20.7 times trailing earnings, a 15 percent premium to its average valuation of 18.8 times trailing earnings over the last 10 years.
[See: 52 Elite Dividend Stocks With Unreal Track Records.]
“Concerns over the long-term decline in soda sales and the corresponding drag on both revenue and earnings, combined with fears of rising cost inflation, had resulted in shares of PepsiCo sliding lower over the first half of 2018,” says Gautam Baid, portfolio manager at Summit Global Investments, a Salt Lake City-based investment firm. (PepsiCo is a top holding in SGI’s fund, SILVX.)
The company has eased investor concerns this quarter, with both revenue and earnings per share beating estimates, Baid says. “In its snack segment, PepsiCo was able to raise prices while still growing volume, thereby preserving margins despite cost inflation,” he says. “Additionally, PepsiCo’s North American beverage sales results improved on the back of market share growth in sparkling water and Pepsi Zero. Organic revenue increased 2.6 percent year-on-year over the last quarter, with core EPS increasing 7 percent.”
The developing world also continues to contribute to Pepsi’s financial growth, as Asia/Middle East revenue jumped 7 percent, with beverage volume up 3.5 percent and snacks volume up 8 percent.
“But the biggest upside came from two areas — Frito Lay North America and North America beverage — both of which exceeded expectations,” Baid says. “Increased media spending for trademark Pepsi has made progress, and Pepsi has done well with Bubly, a new entrant to sparkling water, which PepsiCo says is exceeding expectations.”
Pros to buying PEP stock. PepsiCo’s stock dividend rate of 3.3 percent is a big attraction for income-minded investors and the sentiment for share price growth for a company that sits atop the $200 billion global soft drink and bottled water market would seem to be positive.
“I currently rate PEP as a “hold” for valuation reasons, but income-oriented investors may want to take a look at it,” says Tom Weary, chief investment officer at Lau Associates LLC, in Greenville, Delaware. “PEP traded around $96 in May, at which point I was adding it to portfolios.”
The value in buying PepsiCo is hiding in plain sight, Weary says.
“PEP is a global leader in the food & beverage industry with 90 percent of retail sales from brands that are No. 1 or No. 2 in their category,” he says. “We often associate the company with its eponymous carbonated soft drink brand, but the largest contribution to profits comes from snack foods.”
Currently, Frito Lay North America represents 25 percent of revenue but 42 percent of operating profits in 2017. Comparatively, North America beverages represents 33 percent of revenue, yet only 24 percent of operating profit (the balance being from Quaker Foods North America and international), Weary says.
A shift in product development could work in PEP stock’s favor, too. While soda drinks have come under fire from health experts — studies link soda beverages to obesity and diabetes — snack foods remain highly popular with consumers.
[See: 9 Dividend Aristocrats for Stable Income.]
“While largely reliant upon sugary drinks and salty snacks, for which it receives scorn from critics, under CEO Indra Nooyi the company has made a concerted effort to introduce healthier alternatives to address changing consumer tastes,” Weary says.
Weary has assigned PEP stock a target price-earnings ratio of 20, and with a forward 12-month EPS currently at $5.89, that yields a target price of $118.
“With the stock trading only about $4 below that target price, I would wait for pullbacks to add to this high quality, long-term holding,” he says.
Cons to buying PEP stock. There’s little doubt that PepsiCo’s flagship product, Pepsi, represents a risk going forward as healthy diet advocates continue to slam sugary soft drinks. PepsiCo does have a pretty big insurance policy against sugary beverage declines, as it owns a larger share of the North American non-carbonated beverage market than its competitors.
What’s less apparent, but also important, is when a soft drink and snack kingpin like Pepsi starts to lose younger customers.
“Brand reputation is a key driver of revenue because a sudden drop in perception often precedes a dip in sales,” says Jonas Sickler, a branding expert at New York-based Reputationmanagement.com. “Pepsi has seen a steady erosion of purchase consideration among the 18 to 34 age bracket with a fleeting spike when Pepsi Fire was launched.
“That decline actually began in early 2016,” Sickler adds. “Currently, only 23 percent of millennials would consider buying Pepsi, which is the lowest rate since April 2015.”
The bottom line. By diversifying its product line and with a healthy dividend payout, PepsiCo could provide value for income-minded investors — even as it struggles to attract younger millennials.
[See: 9 Dividend ETFs for Reliable Retirement Income.]
“If PepsiCo’s good performance in beverages continue (thanks to share gains in sparkling water), and the company is able to continue managing cost inflation pressures successfully, then current valuations are expected to sustain,” Baid says.
Right now, PepsiCo dividends are above average at and have been increased for 44 years in a row as a true dividend aristocrat, Baid says. “With a projected consensus earnings [compound annual growth rate] of 8 percent over the next three years, the stock is expected to provide investors with double-digit annual returns over the medium term,” he says.
More from U.S. News
7 Dividend Stocks to Benefit From Trump Tax Changes
7 of the Best Socially Responsible Funds
10 Smart-Beta ETFs That Will Help You Get Your Alpha
Pros and Cons to Buying PepsiCo, Inc. (PEP) Stock originally appeared on usnews.com
