Inside Wall Street: PepsiCo Should Get Its Fizz Back in 2010

Influential money manager George Soros cast a negative spell on the stock market on Apr. 7, 2009 by forecasting that the rally from its March lows was bound to sputter and fail. At the time, Stanley A. Nabi, vice chairman and chief investment officer at Silvercrest Asset Management Group vehemently disagreed. He predicted the opposite, an unpopular view at the time. The market, argued Nabi, would trade much higher. And it did.Indeed, Nabi said he "absolutely felt like a kid in a candy store with so many values to pick at great bargains." At the time, Nabi picked Accenture (ACN), as his top stock choice for 2009. The global leader in management and technology consulting and outsourcing services was trading then at $27 a share. The stock has since vaulted to $43. (Take that, George).

So what's his top stock pick now, for 2010? Nabi's response to the question was quick and confident: "You will be surprised -- it is PepsiCo (PEP)." It was, indeed, surprising because the company hasn't shown pizzazz in 2009, with earnings and sales flattish, and its stock hasn't displayed much fizz in spite of the market's 50% to 60% gain since its March lows.

PepsiCo, the second largest beverage maker, continues to trail No.1 Coca-Cola (KO) and Wall Street seems to have adjusted to what analysts describe as PepsiCo's "lackluster" performance. But of late, some have taken another look and saw it as an opportunistic buy.

A Dividend Increase is Expected

Nabi's argument for buying the stock is based on fundamental and technical factors. "It is trading way below its total asset value and selling at a discount to the Standard & Poor's 500-stock index, despite its strong balance sheet and cash flow," he notes. And the stock has a dividend yield of 2.9%. Nabi expects the company to increase the dividend.

The stock's technical underpinnings are also positive: PepsiCo's price-earnings ratio is at a five-year low of 14.5, based on analysts' estimated 2010 earnings of $4.23 a share. Its PE multiple was as high as 25 in 2008.

Several pros argue that with PepsiCo trading at a 15% discount to Coke, it has become an enticing undervalued asset, in part because of a number of potential catalysts they believe will drive up earnings in 2010 and beyond. So they have started buying shares, which has spurted to $61 a share on Jan. 22, 2010, from a 52-week low of $43.75 on Jan. 15, 2009.

As a beverage company, PepsiCo is much more diverse in its products than Coke: Some 37% of operating profits and 29% of net revenues come from its best-selling line of snack foods in the U.S., including such favorites as Fritos corn chips, Ruffles potato chips and Quaker chewy granola bars.

On beverages, (25% profits and 25% of sales) PepsiCo recognizes that while carbonated soft drinks remain its most popular products, non-carbonated drinks are a faster-growing category. So it continues to come up with new products in this sector, aware of the success of such beverage brands as Aquafina water, Tropicana juice, Lipton tea, and Gatorade. To that end, the company has eliminated trans fat from many of its snack foods and has been introducing "good for you" healthy foods under the Quaker brand. PepsiCo operates in over 200 countries, with international sales accounting for 40% of net sales and more than 34% of operating earnings.

"PepsiCo is our top beverage pick," says Carlos Laboy, an analyst at Credit Suisse who rates the stock outperform, with a 12-month target of $76 a share. (Credit Suisse has done business with PepsiCo).He ranks PepsiCo as "the most likely beverage (stock) to outperform in 2010."

Acquisitions Will Serve as Catalysts, Driving Up the Stock

The acquisition of PepsiCo bottlers PepsiCo Bottling Group and PepsiAmericas, scheduled to close by the end of February, would be one of the catalysts that will drive up earnings and PepsiCo's stock, says Laboy. The merger of the bottlers "offers a low hanging fruit through the second and third quarters," the analyst says.

Another booster would be buybacks, which he expects the company will undertake aggressively after completing the acquisition. "We would not be surprised to see a $4 billion to $6 billion buyback program." Laboy figures PepsiCo will post earnings of $4.23 a share on revenues of $61.9 billion in 2010, up from 2009's estimated $3.72 a share on sales of $43.3 billion. For 2011, he forecasts earnings of $4.76 a share on sales of $65.8 billion.

Because of a number of challenges, PepsiCo is expected to focus more this year on solutions to its problems. Analysts contend that because of its undervalued price, the downside risk in the stock is limited. Of the 17 Street analysts who track PepsiCo, 13 recommend buying the stock, three are neutral, and one rates it a sell.

"In the face of investor skepticism and with its current valuation, we continue to like PepsiCo for 2010," says Michael J. Branca, analyst at Barclays Capital, who rates PepsiCo overweight with a stock price target of $73 a share. Barclays Global Investors is a large PepsiCo shareholder with a 3.8% stake.

One reason why Branca is upbeat: "Full-year 2010 results could surprise the cynics." Should that happen, PepsiCo may turn out to be the drink of 2010 and its stock the surprise winner of the year.

Meet Gene Marcial at the World Money Show Orlando, Feb. 3-6, 2010, at The Gaylord Palms Resort
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