As a value-oriented investor, the issue of the valuation of PepsiCo's stock looms large for me. More specifically, based on reasonable estimates for the company's growth, how investors price the stock, and PepsiCo's dividends, what kind of returns can we expect from the stock?
Let's take a closer look.
As I outlined in a previous article, a good way to get a baseline for growth expectations is to check on what Wall Street analysts expect and how fast the company has actually grown in the past.
Annual Growth Rate
Projected 5-year growth
Last 12 months
Source: Capital IQ, a Standard & Poor's company. Historical growth based on operating earnings.
Before you get too excited about the performance over the last 12 months, it's notable that acquisition costs and other one-time items make the year-over-year growth look a lot better than it actually was. A look at PepsiCo's most recent earnings release shows that on a quarterly basis, total operating profit increased 12% from 2010, while "core" operating profit (which excludes the one-time items) was only up 5%.
But if we look at the bigger picture, PepsiCo has done a mighty fine job of growing over the years. Some of this has come through acquisition, but a lot of it has also come through good old-fashioned organic growth, particularly as the company expands its reach in fast-growing emerging markets.
The question we have to grapple with is how fast PepsiCo can grow in the future. In updated 2011 guidance, the company said it expects to see "high-single-digit" per-share earnings growth, which sounds like it lines up pretty well with the 8.5% long-term growth outlook that Wall Street analysts have. At the same time, PepsiCo's management has been very clear that not only have commodity costs been eating away at profits lately, but that the economic picture is not nearly as good as they had expected.
Combine the tough macro environment with my conservative nature, and you get my mid-point growth expectation of 6.5%. I used analysts' 8.5% as a top-end estimate and dropped down to 3% on the downside.
Pinning down valuation
Valuations are a moving target that can be tough to predict, but, as with growth above, using a range of values can give us a view of our potential returns without requiring a fortuneteller's prescience.
In creating our range, a good place to start is where the stock is trading right now and what its historical trading range has been. Right now, PepsiCo's stock changes hands at just over 16 times trailing earnings. This is at the low end of the valuation range over the past decade, as the stock has traded as high as 36 times earnings and as low as 14 times.
For broader context we can also look at how similar companies trade.
Price-to-Earnings / Growth
Coca-Cola (NYS: KO)
Procter & Gamble (NYS: PG)
Unilever (NYS: UL)
Kraft (NYS: KFT)
Kellogg (NYS: K)
Dr Pepper Snapple (NYS: DPS)
Source: Capital IQ, a Standard & Poor's company.
PepsiCo is an interesting fit in this group because it has both the beverage division -- which competes with the offerings from Coca-Cola and Dr Pepper Snapple -- as well as the snacks division -- which tangles with the likes of Kraft and Kellogg. Based on PepsiCo's forward P/E of 13.4, it looks like it's valued on the low end of either of those two groups. However, when we take into account the lower growth expectations (using the 8.5% analyst number to keep it comparable with the rest of the table) its PEG of 1.58 puts its valuation right in the middle of the pack.
While the valuation multiples for PepsiCo and the other consumer goods companies in the table have been inflated for much of the past decade, I think they've come back to much more reasonable levels lately. On a trailing basis, I think PepsiCo's current P/E of 16 is a good baseline expectation. On the high end, I could see investors paying as much as 20 times earnings, but I also wouldn't be shocked to see that multiple fall to as low as 12.
Dividends and share count
Our final stop is to consider how much we'll get paid through dividends and whether changes in share count will impact our bottom line.
What worries me most about share count is that a company will issue boatloads of shares and dilute my ownership stake. Over the past decade, PepsiCo has used its cash to actually reduce its share count, and it continues to make major capital commitments to share buybacks. As a result, major dilution is a risk that is unlikely to keep me up at night with this company.
As far as dividends, PepsiCo's stock currently yields an attractive 3.3%. The company has been a reliable dividend payer and has steadily grown its payout over the years. My expectation is that it will continue to grow its dividend at roughly a 9% rate, though that could go as high as 12% or as low as 6%.
The verdict, please!
The end result of all of this is the returns we can expect under the various scenarios. Here's what my three scenarios would look like.
Annual Earnings-per-Share Growth
Annual Dividend Growth
Expected Annual Returns
Source: Author's calculations.
To answer the question that we started with -- could PepsiCo's stock be a double? -- in the optimistic case, the answer is a definite "yes." However, these aren't overly impressive results. In order for me to get excited about a stock, I normally like to see returns above 12% in the mid-case scenario. That said, the stability and dependability of PepsiCo's underlying business may make some investors willing to accept a lower return.
Of course the future is an ever-changing picture, so you need to keep on top of what's going on at PepsiCo to see which set of numbers the company and stock are able to live up to. And you can do just that by adding the stock to your Foolish watchlist. Don't have a watchlist yet? Start one up by clicking here.
At the time thisarticle was published The Motley Fool owns shares of PepsiCo and Coca-Cola.Motley Fool newsletter serviceshave recommended buying shares of Kellogg, PepsiCo, Coca-Cola, Unilever, and Procter & Gamble, as well as creating a diagonal call position in PepsiCo. Try any of our Foolish newsletter servicesfree for 30 days. We Fools ma y not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.Fool contributorMatt Koppenhefferdoes not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting hisCAPS portfolio, or you can follow Matt on Twitter@KoppTheFoolorFacebook. The Fool'sdisclosure policyprefers dividends over a sharp stick in the eye.
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