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.  Ratings are based upon 12-18 month outlook on stock direction and not necessarily related to moves I make due to financial positioning.

Today was the day Pepsico announced their first quarter financial results.  Earnings beat analyst estimates by coming in at $0.83 (core constant) and earnings were essentially in line with expectations at $12.22B.  It's safe to say that those results along with the 1.5% increase in core gross margin were better than I was anticipating.  However, my predictions of foreign exchange rates being a problem also came through, as it was a driving factor in reduced revenues and the company's forward guidance, which I'll get to shortly.  

First, I'd like to discuss the upside surprises to the quarter.  Clearly the earnings result was a surprise.  Pepsi is doing an excellent job of driving down expenses and keeping capital expenditures under control.  The company is on track to save a billion dollars in productivity gains while they're also seeing continued success with pricing power and marketing campaigns.  In North America, the cost benefits from lower commodity prices did start showing up on the balance sheet.  The rest of the world was mixed in this area as currency translation continued to rear it's head.  Core organic growth was up 4.4%, which is in line with the mid-single digit rate the company is aiming for.  Finally, EPS grew at a core-constant rate of 12%.  That number was what really caught my eye.  The company consistently aims for high single-digit core competency growth for the year (7-9%) and this number is low-to-mid double digit.  Granted, it's only 1 quarter and not, seasonally, one of its strongest quarters, but wow nonetheless.  To top things off, the company reiterated they were on target for all of their financial goals for the year, despite the foreign exchange impacts.  In all, these items were rather impressive compared to what I was expecting for results.  The company and its management team is delivering on their measurements successfully in the face of challenging times, globally.  

So why did the stock take a nearly 1.6% dive today, one might ask after reading all of those positives.  Well, the answer is pretty simple, I think - foreign exchange impacts.  There are two particular pieces of information that could be found troubling.  First, currency translation impacts have gone from an estimated 7% (something I wasn't previously calculating into my price target and earnings estimate properly) last quarter to 11% now.  The US dollar has paused its ascent against other commodities for a few weeks now, but should that change and it start lifting off again, this number could increase more.  As it stands right now, it takes core earnings estimates down to $4.44.  Add onto that the fact that the company has not changed their forward guidance on forward core competency EPS growth from their 7% target and you should start to pause and wonder what does the remaining 3 quarters look like after recognizing they've grown EPS at a 12% clip so far.  Please note that 12% is on a little less than 19% of the $4.44 projected earnings, though.  It's entirely possible the company is being cautious, given the current environment combined with the fact that they've just provided downward guidance on translation impacts.  You can't blame them for wanting to be cautious if that's the case.  

So what should I or a fellow shareholder do now?  Simply put, I think you stick with it.  I'm going to lower my price target to $98 or 22 times the new $4.44 estimate.  However, at the same time I believe the stock almost has the negative impacts priced in.  I don't really see the stock going below $94 without a major market decline, and should that happen, I hope you're riding it out or buying more if you don't have a full position.  From a technicals position, the stock has a strong floor with the 200 day moving average and that floor is just a little under $95.  Again, I believe it would take a dramatic hit to the overall market to break below that.  I believe your best opportunity to buy the stock will be over the next 3 months.  The company stated in its conference call that while they're buying back shares of stock with their 8.5 - 9.0 billion cash return to shareholders (though dividends and buybacks), the heaviest of it will be in the second half of the year.  I might be reading too much into things, but I translate that to be something along the lines of "we expect the foreign exchange impacts to be a driver to create share price value over the next month, including a potentially disappointing second quarter announcement.  After that, though, things will improve and we will use our purchasing power to take advantage of that value and drive the price up (or provide down-side support) through the rest of the year."  Only time will tell me if I'm right.  I don't think you need to rush to buy the stock.  Be patient, find your price and your time.  It very well may come.  I maintain this stock as a 2 because the company is executing well and the only thing impacting results negatively is the currency translation.  The stock has a solid dividend yield that is reliable and has been increasing at a low double-digit rate for over 10 years now.  However, I am forced to lower my price target to $100.  I consider this to be $98 driven by $4.44 earnings with a 22 multiple plus $2 for stock repurchase impact.