Companies with products and services that are in demand throughout all phases of the economic cycle are often some of the strongest names in the market. Having a business model that works during periods of both economic growth and contraction helps make these companies more immune to the impacts of a recession.
This also enables these companies to routinely raise their dividends. This is not a common occurrence as many companies are at least somewhat vulnerable to the impacts of a recession.
Food and beverage giant PepsiCo Inc. (PEP, Financial) has proven over a long period of time that it is not your average company. The company’s ability to bring to market products that consumers demand has allowed it to pay a rising dividend for more than 50 consecutive years.
There are just 50 companies in total that have a dividend growth streak of this length. Just as important, the company continues to turn out excellent earnings results, offers a compelling yield and trades materially below its intrinsic value. This could make PepsiCo an attractive option to investors looking for growth and income.
Recent earnings results
PepsiCo announced earnings results for the third quarter on Oct. 10, with the company continuing its run of meeting or exceeding analysts’ estimates. Revenue grew almost 7% to $23.5 billion, with top-line numbers in line with expectations. Adjusted earnings per share of $2.25 were up 15% from the prior year’s result of $1.95 per share and were 10 cents better than projected. A 2% headwind from currency exchange to both revenue and earnings was not enough to overcome strong results.
Organic growth for the quarter was 8.8%. Price increases have contributed the bulk of growth over the past few quarters, but demand has not greatly decreased as a result of consumers having to pay a higher amount. Beverage volume was constant for the quarter, with food falling just 2%.
All businesses reported at least mid-single-digit organic growth rates, led by a 12% increase for Frito-Lay. Volume was steady, meaning that higher prices were responsible for the improvement in the segment.
Most regions performed well, led by a 20% increase in sales for Africa, the Middle East and South Asia and a 15% gain for Europe.
If there is a concern it is that PepsiCo Beverages North America experienced the greatest decline in volume. This segment had a volume decrease of 4.5%. However, organic growth for this business was still 9%. This shows that customers, for the most part, are willing to pay up for the company’s brands.
Following results, PepsiCo again raised guidance, with management now expecting adjusted earnings per share of $7.54 for 2023. This would be a 17.5% improvement from the prior year. Management has now raised its guidance for three consecutive quarters. Organic sales growth is now projected to be up 10%, compared to expectations for 8% growth previously.
Takeaways
Organic growth remains elevated at almost 9%. This comes on the heels of a 16% improvement in organic growth in the third quarter of 2022. On a two-year stack basis, PepsiCo’s organic growth is nearly 25%. This is likely one of the best growth rates that investors can find in the packaged food and beverage space.
Most regions experienced a lift in demand. Outside of North America, PepsiCo is enjoying broad based gains in volume across the geographies that it operates. This was not the case even a quarter ago, when volumes declined in most regions.
These factors reinforce how strong of a portfolio PepsiCo has, as the company holds 26 brands that generate more than $1 billion annually. This includes Pepsi, Gatorade, Lay's, Quaker, Lipton and Aquafina. Of these top-selling brands, less than half are carbonated beverages, speaking to the strength of the entire portfolio of products.
PepsiCo has demonstrated its ability to grow even during recessionary periods. For example, the company’s earnings per share grew 13% during the 2007 to 2009 period. The Covid-19 pandemic impacted many businesses, but PepsiCo managed to hold its earnings per share steady in 2020 even in the face of social distancing restrictions before returning to growth in the ensuing years.
Fundamentals look good
Outperforming peers is how PepsiCo has managed to be a successful business over the long term, but recent results coupled with guidance show its future is also bright.
The GF Score of 85 out of 100 implies the company has good outperformance potential. This score is led by good results for profitability, momentum and growth, partially offset by more moderate results for value and financial strength.
PepsiCo ranks near the top of its industry on several metrics, including gross margin, where it scores better than 88% of the competition in the food and beverage industry. The return on invested capital of 12.8% is ahead of its weighted average cost of capital of 6.9%. The ROIC is also better than two-thirds of the company’s peer group. The company does carry a sizeable amount of debt at $35.8 billion, which has resulted in low ratings for the related metrics, but PepsiCo’s interest coverage is one of its best in the last decade.
Overall, the balance sheet is in decent shape. As of Sept. 9, PepsiCo held total assets of $99.95 billion, current assets of $28.7 billion and cash and equivalents of $10 billion. Total liabilities were nearly $81 billion, which includes current liabilities of $23.7 billion.
Dividend and valuation analysis
At 51 years, PepsiCo has one of the longest dividend growth streaks in the market place, demonstrating the company’s ability to continually grow its distribution over a very long period. Operating a portfolio of products that remain in high demand regardless of the state of the economy has enabled the company to raise its dividend for more than five decades.
That dividend growth streak is likely to continue as well. The projected payout ratio for 2023 is 67%, which is in line with the average payout ratio of 64% since 2013.
PepsiCo currently yields 3%, which is almost twice the S&P 500 index’s average yield of 1.6%. The current yield is also slightly ahead of the stock’s 10-year average yield of 2.8%.
Shares of the company have fallen 10% since the start of the year, which has brought the valuation down to a much more reasonable level. Based on guidance for 2023, PepsiCo is trading at close to 22 times forwards earnings estimates. This is just below the long-term average price-earnings ratio of 22.6.
Furthermore, PepsiCo is trading below its intrinsic value, according to the GF Value Line.
PepsiCo has a GF Value of $192.64, which implies a potential gain of 18.6% from current levels. Add in the stock’s dividend yield and total returns could reach into the low 20% range.
Final thoughts
PepsiCo’s most recent quarter showed the company’s products remain in demand across its businesses and regions. Price increases have only slightly slowed demand in some areas, with others still experiencing volume gains. This highlights the quality of the company’s offerings and business model.
The company's long-term success has resulted in a growing dividend for investors, giving it an enviable growth streak. Shares are also trading at a small discount to their historical valuation and could return a high double-digit percentage if they were to reach the GF Value.
This combination of yield and total return potential should make PepsiCo an attractive investment option for investors looking for a combination of growth and income.
