PepsiCo: Limited Upside Potential Given High Valuation
Ashish is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
PepsiCo Inc (NYSE: PEP) share prices recorded an all-time high last week. We believe Pepsi is progressing towards its restructuring initiative goals, with increased marketing spending, strong pricing growth, and brand-building innovation. That said, we believe investments will take another 6-9 months before significantly impacting operating results. With no visible earnings upside in the short-term, investors would need further multiple expansions to see appreciation. However, we believe that at the current stock price of around $72 and P/E of 18.98, a further upside is highly unlikely. The following graph depicts historical share prices versus P/E ratio trends and earnings per share in ttm.
Source: Ycharts
We can clearly see the stock upside is driven by a multiple expansion rather than earnings growth. Thus, we believe the company is fairly valued at this level given some concerns regarding market share lose, weak profit trends (down ~2.5% even on FX-neutral basis) on commodity pressure and higher A&M spending.
Pepsi has struggled enormously in North America, as it faces fierce competition in its beverage segment from The Coca-Cola Company (NYSE: KO) and Monster Beverage Corporation (NASDAQ: MNST), as well as negative effects at Frito-Lay from backlash against unhealthy snacks. Coca cola has increased its hold in the region by gaining declining volumes (down 1%) and revenues (down 5%) reported by Pepsi in the region. Even in overall comparisons, Coca-Cola has done a lot better than Pepsi with a revenue gain of 3% (vs. 2% decline for Pepsi) in the recent quarter and 4% (vs. Pepsi’s flattish revenue) year to date. As a result, Coca-Cola achieved operating income growth whereas Pepsi’s operating profit declined. Despite posting 11% more revenues, Pepsi’s profits were 45% less than Coca-Cola. Given declining market share in the United States, Pepsi will need to increase investment behind the business. In doing so, profitability will further suffer (each $100 million in reinvestment would hurt EPS by 1%)
In addition to declining trends in PepsiCo Americas Beverages, flattish FLNA volumes in 2Q12 (vs. 2% gain prior year) are causing signs of concern. Given weak consumer spending in the Unites States, volume growth in FLNA/PAB has been volatile recently. Going forward, any further decline in these businesses will have a significant impact on earnings. Each 100 basis point of variance in FLNA volume would impact EPS by 0.7%. Each 100 basis point of variance in PAB volumes would impact EPS by 1%.
For investors looking for dividends, we suggest Dr Pepper Snapple Group Inc (NYSE: DPS) over Pepsi. Dr Pepper offers a slightly better dividend yield at a significantly low valuation (~14% discount to Pepsi). With less commodity price risk and zero exposure to the struggling European market, Dr. Pepper is a safer bet. To conclude, we find Pepsi stocks expensive at the current valuation with a limited upside potential and would recommend avoiding it.
TheAnalystBlog 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.
