Earnings Analysis: Pepsico (PEP)
Pepsico announced their fourth quarter and fiscal 2017 year end results back on February 13. Headline results showed a slight beat of expectations with earnings coming inline with expectations at $1.31 and sales beating expectations of $19.38B with results of $19.53B. The company was able to return organic growth back to anticipated levels of 2.3%, most North American segments grew and took share, and the international segments saw growth of mid single digits or higher. The down side continues to be in the North American Beverages division. It's true that they were able to see growth quarter over quarter, which was nice to see - especially after the product placement issues last quarter. However, the growth is still not where expected or desired with an economy in its current state. Pepsi is now about to introduce a new fizzy water called Bubly, which they hope will help bring some life back. Personally speaking, they brought this on much too late. Many people wanted them to buy LaCroix, but that was way too expensive for what you get. I would've preferred to see them buy Natural Ice. Not sure that was any more affordable, but then again, I've been wanting them to do that for at least two years now. The question will be can Bubly bring a taste to people who are interested in this kind of beverage or if LaCroix and Natural Ice have already established dominance in the space that can't be overcome.
It's also important to note what the company is doing now that Tax reform has been passed. The Tax act resulted in a large one-time tax charge for all money overseas, repatriated or not, in addition to many other items to advance capital spending. The company is paying US factory workers a grand a piece as a reward for their work (their words, not mine), and then increasing their dividend by 15% this year, resulting in a $3.70 annual payment as well as opening a three year plan for $15B of share repurchases. Finally, the company is going to use a chunk of money to "double down on new capabilities in areas such as e-commerce, digital, and brand marketing." Again, this is a company taking a windfall of money and using it to advance their causes. I question their push in the e-commerce space as they're not truly a retailer and are not likely to see the impacts as we've seen in retailing, however, it can lend them the ability to help ensure that e-tailers don't get so powerful as to control and compress the company's margins.
Looking ahead, the company expects forward tax rates to be in the low 20s. And are expecting the core earnings to grow another 9% from their $5.23 results in 2017 to $5.70. This sounds likely to be somewhat conservative, as they've been increasing core earnings of 9% annually over the last 5 years. It is important that the company is also accelerating capital projects and other investment efforts, though, so costs will be higher - which is what the company's CFO stated as well. There are a number of new products coming out - two of which were released with the Superbowl (Doritos Blaze and Mountain Dew Ice), which is expected to help build some of these brands and create more interest in the products. Finally, organic growth is expected to stick at 2.3%.
Overall, I think the quarter was good, but not great. I would like to see organic growth 3% or higher in these globally strong economic times, but I think the company is being cautious here, given their exuberance a year ago falling flat. I feel the company is going to continue to be as strong as it has been. Pepsico has been a core holding to my portfolio, though it's been undersized to some of my other holdings. I expect the sizing factor to continue to be the case for now. While a strong company, the stock has been, and I suspect will continue to be, seeing downside pressure. When you have a growing global economy, people aren't as willing to sit in "boring" consumer packaged goods products. Historically, the company had been getting a multiple between 21 and 22. The current prices is about 19.6 times next year's earnings. I feel the multiple people are willing to pay is going to start pulling back this year. Rates will go higher and that makes stocks like this less enticing. Currently, the stock has a yield of about 3.3% which certainly helps its cause for a higher multiple. At the same time, I can see the stock pulling back until yield is between 3.5% and 4% too. That give down side risk in the range of $92.5 - $105.75 and upside I see it pushing to about 3% which hits about $123. I'm going to maintain my "lofty" earnings target of $5.75. I believe as we go through the course of this year, we'll see a fair multiple of 20, putting my 2018 price target at $115. It's important to note that the stock is capable of going up to that 3% yield though - especially early in the year, so leave some room for my price target to be exceeded depending upon timing and interest rates.
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.
It's also important to note what the company is doing now that Tax reform has been passed. The Tax act resulted in a large one-time tax charge for all money overseas, repatriated or not, in addition to many other items to advance capital spending. The company is paying US factory workers a grand a piece as a reward for their work (their words, not mine), and then increasing their dividend by 15% this year, resulting in a $3.70 annual payment as well as opening a three year plan for $15B of share repurchases. Finally, the company is going to use a chunk of money to "double down on new capabilities in areas such as e-commerce, digital, and brand marketing." Again, this is a company taking a windfall of money and using it to advance their causes. I question their push in the e-commerce space as they're not truly a retailer and are not likely to see the impacts as we've seen in retailing, however, it can lend them the ability to help ensure that e-tailers don't get so powerful as to control and compress the company's margins.
Looking ahead, the company expects forward tax rates to be in the low 20s. And are expecting the core earnings to grow another 9% from their $5.23 results in 2017 to $5.70. This sounds likely to be somewhat conservative, as they've been increasing core earnings of 9% annually over the last 5 years. It is important that the company is also accelerating capital projects and other investment efforts, though, so costs will be higher - which is what the company's CFO stated as well. There are a number of new products coming out - two of which were released with the Superbowl (Doritos Blaze and Mountain Dew Ice), which is expected to help build some of these brands and create more interest in the products. Finally, organic growth is expected to stick at 2.3%.
Overall, I think the quarter was good, but not great. I would like to see organic growth 3% or higher in these globally strong economic times, but I think the company is being cautious here, given their exuberance a year ago falling flat. I feel the company is going to continue to be as strong as it has been. Pepsico has been a core holding to my portfolio, though it's been undersized to some of my other holdings. I expect the sizing factor to continue to be the case for now. While a strong company, the stock has been, and I suspect will continue to be, seeing downside pressure. When you have a growing global economy, people aren't as willing to sit in "boring" consumer packaged goods products. Historically, the company had been getting a multiple between 21 and 22. The current prices is about 19.6 times next year's earnings. I feel the multiple people are willing to pay is going to start pulling back this year. Rates will go higher and that makes stocks like this less enticing. Currently, the stock has a yield of about 3.3% which certainly helps its cause for a higher multiple. At the same time, I can see the stock pulling back until yield is between 3.5% and 4% too. That give down side risk in the range of $92.5 - $105.75 and upside I see it pushing to about 3% which hits about $123. I'm going to maintain my "lofty" earnings target of $5.75. I believe as we go through the course of this year, we'll see a fair multiple of 20, putting my 2018 price target at $115. It's important to note that the stock is capable of going up to that 3% yield though - especially early in the year, so leave some room for my price target to be exceeded depending upon timing and interest rates.
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.
Nothing on this site should be taken as advice, research, or an invitation to buy or sell any securities. All views expressed are solely of my own and I am not a professional money manager. Please consult with your financial adviser before taking any action in your own portfolio.
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