Stock Analysis: Pepsico (PEP)

Ding! Ding! Ding!  Welcome to round two of our activist investor showdown!  Yesterday Pepsico announced their first quarter fiscal 2014 earnings.  After the drubbing Nelson Peltz and his firm has given the company since the last earnings call, this was a nice counter-attack - letting it's business, give Peltz the business.  Now for those not aware, Nelson Peltz is a highly respected hedge fund manager.  He has a storied history of convincing various food and packaged goods companies to take actions to benefit the investor (himself and others).  The strategy lately is to break companies up to "unlock value" and this is the proposition being pushed upon Pepsi - requesting that they spin off their snacks division because the beverages division is holding them back.  As a part of the 2013 year end conference call, Pepsi announced their research and findings which they believe proved that there were a very large number of synergies between the snacks and beverages groups that would be lost and hurt both companies if they were to split.  They backed this up with a dramatic increase of cash to investors through both dividends and stock buybacks.  Suffice it to say this didn't go over well.  One quarter in, I'd say Pepsi has pushed into the lead on this fight.  Overall numbers were impressive - handily beating analyst estimates on earnings per share, and slightly beating revenue estimates.  Guidance on the year was maintained.

The Good:
First off has to be the earnings.  Pepsi posted earnings of $0.83 cents when estimates were only $0.75.  Organic growth was 4% or more in each business segment.  Additionally, capital investments that have been made in the past are really starting to show improved returns - helping improve margins.  This is why the company could beat on earnings so definitively despite a relatively marginal beat on revenues and a 47% year over year increase in cash returned to shareholders.  

The Bad or Indifferent:
Revenues compared to last year were essentially flat.  This shows how challenging the consumer has been.  Promotions, sales, and limited price increases, along with a decline in Soda consumption has created headwinds for revenue growth.  However, Pepsi has shown signs that they are starting to turn these challenges around as total soda sales were flat to slightly up on the year.  This will continue to be the challenging area and will be the key area to fighting off the activist charge.

My Stock Ownership Plans:
This is where things get a little tough.  Going into the quarter, I was thinking that the stock may pop to the $85 - 86 range and I would sell based on the belief that stocks like this will soon be getting hit due to macro pressures.  As the economy improves and grows, people will not want to be in slow growing consistent stock that provide yield protection like this.  Facts change, though, and for now I consider this stock to be something worth buying if it pulls back 5-10%.  It has growth prospects, is returning a lot of cash to shareholders, and the yield on the treasury will make a stock like this a nice dividend alternative for a little while yet.  P/E ratios are a little rich, but in line with the industry despite what appears to be improving growth.  As such, I rank this stock a 2 and give it a price target of $90.  This would equate to 19 times earnings expectations of $4.73 for 2014.  Just keep an eye on institutional sentiment towards this sector if interest rates start to increase and/or the economy shows strong growth.  Those events could change the dynamics for this stock.