Another day, another analysis of one of my holdings. Today we'll cover Pepsico. I've held this stock for a couple years now and although there have been some tough times along the way, it's done pretty well for a "safety stock." This was and still is one of my reasons for holding this stock in my portfolio. I wanted something to help keep my portfolio stable and perhaps counter what happens in my more cyclical stocks on bad days. I also picked Pepsico because despite being a relatively safe stock, it also showed signs of growth as it was expanding in foreign markets as well as taking on initiatives to make its products healthier - a common trend in most food stocks which are performing well. At the time of purchase, it also had a very healthy dividend of 3.25% or more, which I have happily been collecting along the way with the positive price performance. But how is Pepsi shaping up now? Does it have room to run, or is it time to let go?
Let's start with the positives. Despite a year that hasn't been as good as the company originally hoped, Pepsi has been continually performing adequately compared to its major competitors. The one thing that you have to keep in mind about Pepsi that makes the comps more complicated is the fact that they have the food divisions to go with the beverage divisions. Coke and Dr Pepper/Snapple are pure beverage plays. This leaves Pepsico with an upper hand because despite not wanting to (and I can't say I want them to at this point either), Pepsi does have the ability to unlock shareholder value through spin-offs or sales of parts of the company. I don't think it's necessary at this point, but if the company isn't getting a stock value of what it's worth, at least they can do something to bring out that value. Another thing to consider is that just last quarter Pepsi took some measures to enhance margins and reduce expenses, which should start paying out over the first and second quarters of 2013. From a technical perspective, the stock has been performed exceptionally well from May to August last year before pulling back and putting in a new baseline. During January, so far, the stock has started to lift off from its new base. The last big plus to this company has been its dividend. It's recently gone down below 3%, which isn't totally awesome like it was originally, but PEP is also know for it's yearly dividend increases. My guess, right now, is that they'll raise the annual dividend to $2.24 which will be about a 4% increase and have the yield at 3.11% at today's prices of 71.81. It's always nice to have this because if something goes wrong with the markets, this will help provide a stronger floor to prevent the stock from going down as long as there's cash flow to support the dividend and there doesn't seem to be an issue with that here yet.
What are the risks, though, and how bad are they? Well, there are definitely a few risks here. The biggest is their margins. Margins are and will be affected by commodity costs - particularly corn. With the drought suffered through the midwest last year and it continuing to be dry through the fall and winter, there is significant risk that commodity prices will rise again. In addition, China is growing and will increase the demand for corn which can also raise prices. This kind of event happened during the summer of 2011 as well, although that was driven more by high oil and gas prices. During that time Pepsi took a hard hit because they couldn't easily pass price increases along - especially in the US where the economic recovery was struggling. Today, our recovery is stronger, but not healthy yet and there are other parts of the world which are still slowly recovering. International growth might help top line numbers, but this is a significant risk to the bottom line numbers. The next risk is how much the stock has climbed in comparison to the company's earnings. Earnings growth has slowed and I'm concerned that the stock might be getting too strong in comparison. The typical average for this stock is to be at 17 time earnings, which is about where we're at today. My current guess is that earnings will only be around 6% next year as well. That doesn't leave much room for growth unless there's a strong reason for the multiple to expand. The final risk I see at this point is that we're looking at a shift in the state of both the US and the world economies. Things are getting better, risk appetites are increasing and when that happens, safety stocks don't grow near as fast as the rest of your portfolio - they may even decrease, particularly when commodity inflation is a concern as we've indicated. Right now, I'm predicting 2013 earnings to be around $4.30 - 6% increase over where I expect 2012 will end. That leaves my price target at $75. There are enough risks here that I'm preparing to sell my position of PEP unless at least 1 of 2 things happen. First thing is that the price shows signs of putting in another base again - trading sideways for awhile. The second is the more important one - I need to hear what's expected in the next year on the February 14 conference call. This call could be huge in regards to margin control, the ability to push price increases, and overall growth expectations. If the information isn't strong, I think I need to look to sell and find something more appropriate for the current environment.
To conclude, Pepsi is a great safety stock that has shown it has the leadership to pursue appropriate trends, dedicate itself to returning profits to shareholders and still has the ability to grow internationally. However, there are potential supply and market risks to this stock which make this company one you really need to pour over the conference call on. The results from this meeting can help indicate what growth or challenges lie ahead and how much confidence the analysts have that there's value in paying up for the stock.