Earnings Analysis: Pepsico (PEP)

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.

Back on Thursday, Pepsico announced their 2015 fourth quarter results.  Overall performance was generally in line with analyst expectations as core EPS came in at $1.06 and revenues were $18.58B  The earnings resulted in a 10% core constant EPS growth, but was dramatically impacted by foreign exchange rates, which resulted in revenues being down 7% for the quarter.  Historical results weren't anything to complain about as the company met or exceeded on all financial goals they established for the year.  That said, forward guidance certainly was a wet blanket, of sorts.  It's not exactly surprising, as we've seen similar tales told by other consumer packaged goods companies such as Proctor & Gamble or Coke.  That said, earnings estimates were a lot lower than I expected.  I'm not quite sure where I went wrong on my estimates, but the company guided their earnings at $4.66, which is about 2% higher than the $4.57 they earned this year.  Don't let that completely fool you, though, as you need to back out about ten cents of earnings in this year's results as a result of the deconsolidation of Venezuela that was announced at the end of the Third quarter.  When you factor That in, the company is forecasting approximately 4% of revenue grown on a core constant currency basis.  While better than initial looks, it is a bit disappointing after they were able to grow earnings 10% this year.

Execution was a solid highlight for the company on the year as they hit all of those financial goals in a very difficult macro environment.  Outside of the US, Pepsic sees only a couple countries that appear to be doing well.  The vast majority of countries are suffering from slow growth or recessions throughout the globe.  Even the US was called out to be on shaky ground.  Given this macro setup, we see 3 risks to CPG companies, according to Pepsico.  It creates a stronger US dollar, which hurts both the translation of goods and revenue results due to currency translation upon reporting.  The environment also creates volatile markets, resulting in less corporate spending and investment - this creates less money being passed through the economic system for purchasing power.  Finally, weak economic performances creates unstable geopolitical and economic environments, much as we've been seeing since the start of the year (if not much of 2015 too).  As people are fighting to survive, you see upheaval, fighting, coups, wars, and other events which make markets difficult to serve.  Personally, one of the biggest pieces I took away from Pepsi was the impact of currency translation and how it impacts in multiple ways.  To help highlight this, it was noted that commodity costs, which I've seen to be a source of increased margins, have actually been deflating, as I expected.  However, when you factor currency translations, commodities are still inflating by a small percentage.  The ability to increase margins, as I expected, doesn't exist in this environment.  

While Pepsico did deliver one expectations, they also have increased their dividend payouts by 7.1% to $3.01 from $2.81.  This puts the stock's yield back at 3.06% based off of Friday's close.  In all honesty, this is one of the primary factors to why the stock has been staying stable.  With an expected $7B in free cash flow next year, there are no worries that shareholders will see cuts, the company also plans about $3B in share repurchases.  With the 10-year down at lows we haven't seen in years, this helps provide some income assurance.  That said, it's hard to say the stock isn't getting overpriced given they're growth and forecasts, either.  Even if we maintain their multiple of 22, the 2016 target is now only at $102.50 based on the earnings estimates provided.  Currency translation is preventing true growth.  As long as the global situations stay as difficult as they are, it will be hard-pressed to see any true growth.  On top of that, once we do see some true growth, it's more likely that the stock will fall out of favor for companies with higher growth.  When CPG companies hit a period of time where they become revalued, there could be a lot of pain.  I can see a stock like Pepsico, which closed on Friday at a price of over $98, to drop down anywhere between $74 and $83 before it becomes a strong value again.  For now, I don't see that has a worry.  There's too much need for safety and consistency.  Later in the year, that could always change.  For now, I see the stock going up, before it goes down much more.  That said, be careful of greed, as we approach and surpass price targets.  

Given all the circumstances I've provided, I'm lowering my earnings estimates to $4.68 - I believe the company is capable of beating some of the marks they set and they're using the environment to help reset expectations.  As long as we're under the global economic strife we've been experiencing so far this year, this is a good stock to "hide" in.  That said, the price is way too rich to buy - it should've been bought back in August and September of last year (hindsight, of course).  My price target for the stock is $103 - a price to watch as that's also around the point of its 52-week high.  The stock also stays ranked at a 2 as long as current conditions persist - which should be most of 2016, at the least, I predict.  As things change, you really need to reassess what to do with this stock.