Friday, July 25, 2014

Stock Analysis: Pepsico (PEP)

Notes:
Stock Ratings: 1 = buy at current stock prices, 2 = buy on a 5-10% dip in stock price, 3 = sell on a 5-10% increase in stock price, 4 = sell at current stock prices to raise cash


Wednesday, Pepsico announced solid results for the second quarter.  This might be a somewhat muted reaction to the results.  Truth is Pepsi announced a fantastic quarter when you compare what they've delivered compared to what many other similar/competitive companies have announced so far.  This leaves me grateful I didn't sell a single share over the last quarter, but at the same time shameful for having doubt in the company and the stock.  I feared the stock was getting too rich for its growth and the yield was getting too small.  There may be some truth to these items, but interest rates are low, portfolios need to be diversified, and Pepsi has been the best in the consumer goods sector bar none.  Earnings came in at $1.32, which handily beat the $1.23 estimates analysts had, they also beat on revenues with a posting of $16.9 Billion.  Finally, they completed the trifecta of an excellent earnings announcement by increasing the guidance by raising EPS growth estimates from 7% to 8%.  

Another nice piece to the quarter was the growth rate of the gross margin.  It has expanded much faster than people expected.  These margin increases are part of a plan which is on target to find $1 Billion in savings and efficiency gains in the course of 2014.  I also have a feeling that falling commodity prices are playing a factor into this as well.  

Positives include the dropping of commodity costs which should help accelerate margin growth going into 2015.  This coupled with EPS growth which has potential to reach 10% year over year growth at some point next year make this stock great to own.  Dividend increases are a staple to this company, and its yield is still respectable.  Finally, the leadership team is just superb.  They're reliable and they deliver.  The stock deserves the premium it goes for and then some yet.  I can see this stock getting to 22 times earnings before it might start looking rich based on what I'm seeing.

There are some risks with the stock, though.  One is commodity prices will increase.  If this happens, it will eat into gross margins - though not likely until the latter half of 2015 at the earliest.  The stock still holds favor as a haven to counter the low interest rates as well.  If rates start climbing - especially if they start climbing quickly like they did in the first quarter of the year - a 5%-10% pullback in the stock price is almost a sure thing as people will cash in their gains and look for better yield.  This coupled with economy growth will also take the sector out of favor at some point as well.  When that happens, it doesn't matter how well the company is doing, the stock will lag the S&P 500.

With the positive quarter and new information, I'm upgrading this stocks ranking to a 2.  I believe the company will earn $4.71 in 2014 and that will likely grow to $5.10 in 2015.  As such, I give the stock an 18 month price target of $102 which would price the stock at twenty times 2015 earnings.