Should PepsiCo Be Your Next Buy?
Earlier in the week, I made a promise that I'd abandon my unfocused ways and dig into five stocks that look particularly interesting right now.
Don't forget the snacks: PepsiCo's business
Though PepsiCo breaks itself up into six segments for its financial reporting, when I think about it, I tend to think of it on the basis of two separate splits: beverages and snacks, and U.S. and international.
Since the company is named after its flagship fizzy beverage, it's very easy to think about the company's beverage business and stack it up with Coca-Cola (NYS: KO) and Dr Pepper Snapple (NYS: DPS) . And, to be sure, the beverage business is a very important one for PepsiCo.
However, it's a big mistake to overlook the snacks business, a segment that includes brands like Lays, Doritos, Tostitos, Cap'n Crunch, and Quaker. In the U.S., PepsiCo controls close to 40% of the savory snack market as compared to 10% and 5%, respectively, for competitors Kraft (NYS: KFT) and Kellogg (NYS: K) . This piece of the business is not only large -- it reported $5.5 billion in second-quarter revenue in the Americas region versus $5.6 billion in the Americas beverage group -- but it's growing at a much faster pace than beverages in many parts of the world.
In short, with PepsiCo you're getting a global leader in tasty beverages and savory snacks.
Looking abroad: PepsiCo's opportunities
There are two opportunities that PepsiCo is working on that I'm most excited about. First, there's international growth. In 2010, 53% of the company's revenue came from the U.S. and large chunks came from other developed markets like Canada, the U.K., and other parts of Western Europe. PepsiCo has its sights firmly set on huge emerging markets such as Russia (where it purchased Wimm-Bill-Dann), China, and India. It's not a given that the company will be wildly successful in these faraway lands, but there is significant opportunity if it can find the right formula.
Meanwhile, the company has been on a push to increase the "good for you" component of its portfolio. Back in 2000, 11% of the company's $20 billion in revenue came from products that it considered "good for you" -- all in beverages. In 2010, that component had increased to 21% of its $62 billion in revenue and was made up of both food and beverage products.
PepsiCo isn't totally out of its element in this push -- Gatorade has been part of its beverage portfolio since the 2001 acquisition. But the healthy-food market isn't exactly second nature for a company that sells Cheetos and Cracker Jack.
Risks to the business
The most noticeable risks for PepsiCo are likely shorter-term risks. Like many other consumer goods companies, PepsiCo has been struggling with commodity-cost inflation lately. As the price for goods like aluminum and corn increases, the profit that PepsiCo makes on its products falls. Like most other companies in the industry, PepsiCo is raising prices to offset some of the impact. However, if input costs continue to rise at a rapid clip, investors may see some profit chipped off the bottom line.
Complicating the rising cost situation is the fact that the broader economy has been tougher than the company was expecting. Not only does this mean more difficulty selling products, period, but it also makes it that much harder to get consumers to swallow price increases. Without making an economic prediction here, I'll simply say that if the U.S. -- and perhaps global -- economy continues to sputter, investors will certainly see that reflected in PepsiCo's results.
Looking to the longer term, there are fewer specific risks that I'm really concerned about at PepsiCo. At one point Warren Buffett said that he likes businesses that can be run by a ham sandwich. PepsiCo meets that criterion. With global powerhouse brands like Pepsi, Mountain Dew, Frito-Lay, Gatorade, and Quaker, it'd take some hard work to really screw up the company.
That said, there are still long-term execution risks. Too hard of a push in the direction of "good for you" foods could end up alienating the core snacks customer that just wants something that tastes good. And just because emerging-market growth is there for the taking doesn't mean it will be taken. PepsiCo will have to have the right products, tastes, and marketing if it wants to truly win in those fast-growing areas.
Measuring up: The stock's valuation
This issue could be a subheading under risks, because overpaying for a stock like PepsiCo may be one of the bigger risks for investors. When working with a fast-growing company, you can often afford to be a little loosey-goosey when it comes to valuations because, if everything works out, you can get bailed out by the high growth.
With PepsiCo -- a $100 billion company that analysts expect will grow 8.5% per year -- it's unlikely that we're going to see a huge upside to growth expectations. In fact, I think if anything, analysts' estimates will prove optimistic and the company won't actually grow that fast.
Because valuation is particularly important to me, I dug into that aspect separately here. The bottom line, though? The way PepsiCo's stock is priced today, I think investors can expect an annual return of around 10%. That's pretty reasonable -- particularly for such a large, dependable company -- but below the 12% level that I usually like to pounce on.
I really like PepsiCo the company. How could I not? It's a stable business with great brands, solid financial performance, and a nice 3.3% dividend. The biggest risks will likely prove to be (relatively) short-term, and there are some very significant opportunities.
For someone planning to hang on to the stock -- as opposed to trying to trade it -- I don't think a purchase at today's price would be disappointing. That said, I'd be a much more excited buyer at a slightly lower price.
Hopefully I've given you a lot to think about here. As you digest this and dig into the numbers yourself, you should go ahead and add PepsiCo to your watchlist to keep up with what's going on at the company in the meantime. Don't have a watchlist? You're in luck; you can start one for free by clicking here.
At the time this article was published The Motley Fool owns shares of PepsiCo and Coca-Cola.Motley Fool newsletter serviceshave recommended buying shares of PepsiCo, Kellogg, and Coca-Cola, and creating a diagonal call position in PepsiCo. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may 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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