Finanzas: PepsiCo 2016 Results Were Good
- PEP has recently impressed with their volume growth performance which was reflected in their FY2016 results.
- Cash flow performance also remained strong with only debt growth a minor irritant.
- PEP enters 2017 with solid momentum, though there are a number of things investors should keep an eye on.
- Right now, despite the clear appeal of the business, the share price appears to be overvalued and so worth waiting for a modest pullback.
PepsiCo (NYSE:PEP) has been increasingly closely watched by me. When I last wrote on them at Q3 2016 results time I was impressed by the general performance of the company and, in particular, its volume growth figures. Now we have their FY2016 results in hand, am I still as impressed?
The short answer is “yes.” I still have, however, reservations around the pace of debt growth and their valuation. Nonetheless, as we shall see, PepsiCo remains one of those perennially attractive, highly cash-generative, defensive income stocks which every investor should at least take a look at from time to time. As we look towards 2017 I think this is even more true.
Top and Bottom Line Strength
First, PepsiCo’s headline-grabbing top and bottom line performance made pretty good reading. Despite reported figures showing a rather sharp difference between operating profit and revenue performance, the underlying organic growth of both was healthy.
Although still overshadowed by 2015’s performance, it shows that PepsiCo has still managed to generate healthy levels of organic revenue growth in what remains a tough global market. I was therefore not that surprised that the company is forecasting just a 3% organic revenue growth figure for 2017. Whether or not this is conservative or not will only become clear with time. Yet with them leaving H2 2016 at over 4% organic growth, there may well be an opportunity for a positive surprise in their future reported figures.
Where PepsiCo has impressed me more in recent results announcements, however, has been with regard their volume growth. This is still the case. Nonetheless, it remains focused more on their non-North American businesses.
Still the largest part of their business is the North American (“NA”) region. Together their core, home markets represent over 62% of revenue and 75% of operating income in 2016
Generally speaking these core segments performed robustly rather than spectacularly. Their largest, iconic beverages segment managed to produce a similar 1% growth as seen in 2015. Frito Lay, in contrast, managed to produce growth of 1.5%: half a percentage point ahead of last year. Nonetheless, it is clear that Quaker Foods continues to be a drag on North American volume growth with a flat performance once again
Although Latin America continues to struggle with the beverages segment falling 2% in volume, other than this their non-North American business saw expanding volume growth rates in 2016 compared to 2015.
For me, this is immensely encouraging. Nonetheless, it is important to note that Q4 saw a marked slowdown in beverage growth from the pace seen in Q1 2016.
This was caused by a general slowdown in beverage volume growth across all regions compared to Q1 2016 and not just weakness in their Latin American beverages business. Although I leave FY2016 pretty happy with their general volume growth performance, this latter point is something I plan to trace very carefully as we progress into 2017 and beyond.
For investors, however, the centerpiece of any look at PepsiCo has to be its cash flow. And here it continued to present a compelling picture. Although FCF actually fell a little on last year, they still generated over $7 billion and the fall on 2015 was chiefly due to higher CapEx.
With dividends representing a bill of about $4.25 billion in 2016 (of which more later), this means that they only paid out about 57% of their FCF to service it. That is great news. What is more, the company expects to see a similar performance in 2017, as their CFO High Johnston explained (Source: FY2016 Results Earnings Call Transcript):
Turning to cash flow, we expect to continue to generate strong cash flow [of] approximately $10 billion in cash flow from operations, net capital spending [CapEx] of approximately $3 billion [and] approximately $7 billion in free cash flow, excluding certain items.
Although hardly the most eye-catching change on 2016’s FCF performance, it is clear that they expect to see PepsiCo continue its history as a strong, stable cash flow machine. This is superb as it underpins an awful lot of the appeal that PepsiCo holds for investors.
Nonetheless, the fall in FCF in 2016 has impacted upon their cash return on invested capital (“CROIC”) rate. Calculated by dividing their FCF by the total capital invested in the business (total debt and shareholders’ equity) their CROIC tells us how efficiently they generated that cash. In 2016, this was slightly lower than in recent year.
Yet, at over 15% it remains compellingly high and suggests that for every $100 of capital invested in the business they continue to generate over $15 in FCF. For me, anything over 10% is an attractive rate of return. PepsiCo is, therefore, still looking immensely impressive on this front.
What is worthy of note, however, is another cause of that falling CROIC. Sure, a modestly weaker FCF figure played its part. Yet on the other side of the equation PepsiCo continues to drive its debt levels higher still.
They ended 2016 with nearly $37 billion in debt-over $10 billion more than at the end of 2011. Indeed, it represented another 11% growth on the debt levels seen in 2015 which is the second year of double-digit growth.
Sure, this is largely driven by the desire to lock-in lower interest rates before they begin to rise more consistently. With a sizeable, growing dividend obligation they may also be able to justify the long-term returns of using this to help buy back shares. Similarly, it can be highlighted that they have been more conservative than their equally iconic beverage peer, Coca-Cola (NYSE:KO), with regards to the rate of their growth.
Nonetheless, every $100 of debt in 2011 has grown to $138 in debt in 2016.
Bearing in mind this was hardly from a low baseline to begin with, it is hardly something that investors should welcome. It is therefore of little surprise to find that their debt-to-equity levels are now at pretty staggeringly inflated looking levels.
At nearly 20% coverage, this means that (theoretically) they could repay their entire debt load in just over five years using their FCF alone. Although weaker than I would prefer (I look for 25% or above for my ideal sort of level) it still remains a strong coverage level.
What I would like to see, however, is for debt growth to slow (or even reverse) markedly in coming years. Though their defensive, cash-generative nature may well make them an attractive business to lend to at attractive interest rates I can’t see it as particularly investor-friendly to continue to build leverage levels at its current pace.
The reality is that PepsiCo also remains a compelling income champion. PepsiCo has consistently paid out the vast majority of its FCF to shareholders either through dividends or share buybacks.
As well as keeping the dividend yield around the 3% mark, the addition of consistent buybacks has led to a total shareholders’ yield (both dividend and buyback contribution combined) sitting comfortably above 4% since 2009.
Nor is this set to end anytime soon, it seems. PepsiCo’s CFO, Hugh Johnston, stated that in 2017 investors should expect to see: cash dividends of approximately $4.5 billion and share repurchases of approximately $2 billion.
As a result, again investors should see most of PepsiCo’s FCF being paid out to investors. Indeed, according to my dividend predictions we should see PepsiCo yielding about 2.9% and 3.1% on today’s share price this year and next.
Certainly with FCF growth pretty much static we should note that payout ratios will also likely rise, however, even though they will likely remains at fairly healthy levels. Despite this, PepsiCo still looks set to remain an appealing income stock with consistent dividend growth set to continue building on their impressive 44-year dividend growth history.
PepsiCo’s results looked like the exact kind of solid figures we have come to expect from the consumer goods giant. I am therefore immensely interested to see whether they can keep that momentum into 2017. The company itself highlighted, however, that Q1 2017 should not be expected to be a stand-out performer. The first quarter will see “organic revenue growth … rates … below our full-year guidance levels” of about 3% in 2017 due to a variety of factors including:
First, at this stage of the quarter, we expect organic sales to decline at our AMENA [Asia-Middle East-North Africa] division, driven by increased levels of volatility throughout the region and Chinese New Year timing. Second, holiday calendar shifts will modestly impact our top-line results in North America. Third, FLNA [Frito Lay] and NAB [North American Beverages] face very difficult operating profit growth comparisons, as they lap both input cost deflation from last year.
As a result, we may have to wait until Q2 2017 to really get a good idea as to what sort of condition the FY2017 performance may be like.
What I do expect to see is cash flow remaining impressively high and shareholder returns generous. Something I will be watching closely, however, remains their debt growth. Hopefully the last two years’ double-digit growth will represent the peak of their accelerated debt growth as interest rates start to move higher and debt becomes more expensive to pick up. Hopefully this we should start to get some sort of indication of in the first few quarters. I don’t expect PepsiCo will be in a rush to pay down current levels, but I do hope to see more stable levels in the near future.
My biggest issue with PepsiCo right now, however, has to be its valuation. Back at Q3 2016 time, I came out with a fair value somewhere between $100 and $105 per share. Using the same three-part valuation method after FY2016 results and looking to FY2017 and FY2018 suggests a new tighter fair value range of between $101.50 and $104. At nearly $110 at present, it is running about 6-8% ahead of my fair value price.
Although undoubtedly an attractively premium-quality company, I’d probably prefer to wait to see its premium on its own historic trading levels to be trimmed back (especially until we get a better understanding of their future debt growth trajectory). Immediate investor reaction to the predicted weaker Q1 2017 results may well offer an opportunity for just that.
Nonetheless, its high-quality cash flow, significant income appeal and impressive volume growth figures are a major pull. As a result, PepsiCo remains very high on my watchlist even if I am not quite ready to open a position.
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