Pepsi Dividend – Slowing Or Growing?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

PepsiCo (NYSE: PEP) has been a favorite of dividend investors for a long time. It's not hard to understand why. With the company's most recent increase the dividend has been growing for 40 years. Just as an example of the power of rising dividends, you could have bought Pepsi 10 years ago for about $50 a share. While the 3.28% average increase in the stock price isn't much to write home about, the dividend is a different matter. Back in 2002 your yield would have been just 1.2%, ten years later your effective yield is now 4.3%. Since this 4.3% yield beats many fixed income investments, this is something to brag about. The question is, can this dividend growth continue?

Today's investors can buy Pepsi with a yield of about 3.24%. That's pretty good compared to nearly any Treasury product or CD. The difference between Pepsi today versus 10 years ago is age. As companies get larger, it's harder for them to grow quickly. For years if you looked at the expected growth rate of PepsiCo, you would routinely see analysts calling for 8-10% growth. Today that future growth rate is just 4.86%. While Pepsi holds the keys to some of the most famous brands in the world, namely Pepsi, Tropicana, Ocean Spray, and Mountain Dew, the two largest growth areas in today's market are water and energy drinks. While Pepsi's SoBe and Aquafina water brands are well received, the company's AMP energy drink just doesn't compete well against category leader Monster Beverage (NASDAQ: MNST). I've made the argument before that Coca-Cola (NYSE: KO) would do well to consider a takeover of Monster Beverage. The same holds true for PepsiCo. Monster has both superior cash flow and earnings growth that could help either soda titan. Unless or until that happens though, Pepsi will have to make the most of what they have.

What Pepsi has is free cash flow and a lot of it. In the last three years, while Pepsi's earnings increased by 2.79% annually, their cash flow has increased by nearly 11% annually. This huge cash flow allows the company to both increase the dividend, while actually lowering its free cash flow payout ratio. In fact, in the last three years, the company's free cash flow payout ratio has dropped from over 58% to about 56%. The growth of the dividend, that's somewhat a different story.

Look at the difference in dividend growth over the last 10 years:

<img src="/media/images/user_93/pepsi-dividend-growth_large.jpg" />

You can see that prior to 2008, 15% dividend increases were somewhat the norm. However, since 2008 the average rate of increase has dropped to just over 6% annually. The most recent increase was the slowest yet at just 4%. Why the slowdown? Well the economy certainly hasn't helped, but another factor could be the 178% increase in long-term debt in the last three years. This is due in large part to Pepsi's acquisition of their bottling group in 2009, but this larger debt load means additional costs. While longer-term this should be a net positive for Pepsi, short-term it puts pressure on management to be conservative with the dividend.

Going forward, Pepsi investors should probably expect more of the same. I would look for 4-8% annual increases in the dividend. While Pepsi management gets used to the additional debt on the balance sheet, and navigates a slowly improving economy, the dividend can't grow like it used to. With just 5% EPS growth expected, and a just over 3% dividend, Pepsi isn't the same stock it used to be. Investors need to accept that shares should be less volatile due to the higher yield, but they also aren't going to see a lot of price appreciation. The stock will likely follow the dividend increases going forward as the multiple compresses to adjust for this slower growth rate. While 40 years of dividend increases is impressive, I would suggest investors look elsewhere for better dividend growth in the future.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of The Coca-Cola Company and PepsiCo. Motley Fool newsletter services recommend Monster Beverage, PepsiCo, and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.

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