Thursday, July 9, 2015

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.

I get the feeling I've been in this position before.  I find myself in a position where the stock has pulled back and I start thinking we're entering a time that may no longer be wise to hold the stock.  And just as I'm preparing to sell the stock, an earnings release comes out and hits me upside the head like someone swinging a 12-pack of Mountain Dew at it.  This was one of those moments.  Today Pepsico announced earnings of $1.33 on $15.9B in revenues.  Earnings were significantly higher than anticipated and revenues were a nice beat, despite ongoing pressure from foreign exchange translation.  Margins were up on improved pricing and operating efficiency, both snacks and beverages witnessed organic growth and the company raised its guidance from 7% organic growth for the year to 8%.  All other factors, including the 11% hit to revenue, due to FX stayed in place.  I'm not sure about anyone else, but this isn't a company that seems to be struggling.  This is what happens when you have a management team that knows how to execute.  Stocks may fluctuate for various reasons, but do you really want to pull away from execution like this in a medium to long-term investment?  I'm pretty sure I don't at this point.

So what are the risks and bad news?  Well, the primary risk I see right now is really about currency translation.  The -11% impact from this is really a pain to see when organically, the company is surging.  Add into this a changing macro environment which has the potential to send the dollar even higher, and there's certainly translation risk in front of us.  Additionally, if they change how they measure Venezuela translation, there could be another 2% hit that's not being accounted for in guidance right now.  The other risk that exists is the Fed and interest rate hikes.  I have said that CPG companies, such as this one, tend to get hit when rates start rising and bonds have safer, returns on competitive yields.  As of today's close, PEP has just under a 3% yield, while with all of the macro and geopolitical antics going on with China's stock market crashing and Greece looking at strong potential to getting a boot out of the Euro, and US interest rates have been dropping quickly recently.  The "sure thing" that even I've been talking about regarding rates rising in September is now coming into question.  With the world economy hurting, major commodities and indexes falling, and a data dependent Fed, there's increased potential that they don't start raising yet.  At the very least, things become less sure and therefore become more volatile.

So I liked the quarter.  Now what?  For starters, I'm going to upgrade the stock back to a 2, however, I'm going to stipulate it.  As long as Treasuries are below 3 - 3.5%, I feel the stock can maintain these high PE multiples.  When rates start rising - when, not before - I think that's the time to start looking at making sure PEP is a lighter holding in the portfolio.  Maybe not best to blow out completely, but you're likely to take a hit as you probably will see multiple compression.  The way the market has been, things are too volatile on too much interest rate speculation to take different action.  You may not get out at the top as some people will take a risk before rate changes happen, but unless I have better info other than "I think," it just hasn't been a good approach for me.  Next comes my estimates.  Due to this quarter's reports, I'm raising my 2015 earnings guidance to $4.50 from $4.44.  The company guided to $4.49 on this quarter and I'm just rounding and giving the strong team some additional credit.  On the current 22 times price multiple, that puts my price target at $99.  To coincide with my warnings of multiple compression on higher yields, I see the downside risk to be a multiple of 18-19 times earnings.  This would put a floor in around the $81-$85 price range.  Again, I don't see that a likely risk under the current economic environment and, instead, see the current floor around $93.50, but there is a ceiling around $95.  Technical indicators show the 50 day average turning around and if it crosses the 200 day, we should break through the ceiling.  With current market turbulence, it's a time will tell situation.  In the end, expect volatility and know what's influencing the stock.  The management team is great, so in the multi-year outlook, I can assure you'll continue to see increased dividends (10% CAGR historically) and the stock will trend higher.