PepsiCo (NYSE:PEP) is doing a pretty good job dealing with the current market. Although revenues were down in the just ended fiscal third quarter, most of that decline was due to currency fluctuations. In fact, the soda, snack, and food company was so pleased with its own results that it upped its guidance for the year. What’s not to like about this story? Valuation…
A great business
There’s no question in my mind that PepsiCo has a great business. It has two core operations, drinks and snacks. Both are frequently purchased, low-cost items that tend have loyal customers. In other words, even when the world looks like it’s coming to a financial end, Pepsi’s business should hold up relatively well. The other part of the business is a branded food operation underpinned by iconic Quaker Oats. Like drinks and snacks, it’s sells frequently purchased low-cost item with loyal customers. This product diversity is, in my eyes, a real benefit over main competitor Coca-Cola (NYSE:KO), which only operates in the drinks space.
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Moreover, PepsiCo has a global footprint that is really only rivaled by Coca-Cola. That includes names that everyone knows and the distribution system to push those names into large and small stores the world over. That’s not something you build over night, it takes decades and helps differentiate Pepsi (and Coke) from its smaller competitors. It also puts Pepsi in a position to quickly benefit from acquisitions and product innovation, since it can leverage new products across its vast distribution network.
So, there’s clearly a lot to like about PepsiCo. That includes that fact that it just posted solid quarterly results. For example, the third quarter saw overall revenues fall around 1.9%, but that was driven largely by a 3% negative impact from foreign exchange rates. There’s little PepsiCo can do about foreign exchange rate moves. Organic revenue growth, which strips out things like currency changes, was up just over 4%.
That’s pretty good news and backs up the long-term story that PepsiCo has a consistent business. Core earnings were up 7%, too. And, even more exciting, the company announced that it was increasing its full-year core earnings guidance. There’s plenty of reason to like PepsiCo as a company.
What’s not to like?
But I still can’t say I’m pleased with PepsiCo as an investment option. That’s because the biggest risk today isn’t in the company’s business, it’s in the valuation investors are affording the shares. Let’s put some numbers to that statement.
PepsiCo’s trailing price to earnings ratio is just over 30 compared to a five year average of roughly 20. That’s a full 50% higher than the recent norm. I don’t think you can say that it’s results are 50% better than average. For example, the company’s top line has pretty much gone nowhere since 2011 and the bottom line hasn’t exactly been lighting the world on fire, even though this year should see solid results.
But it isn’t just the P/E that’s out of line with the recent past. The price to sales ratio is around 2.6 compared to an average of 1.9. Price to book is around 12.8 compared to a five year average of 5.9. Price to cash flow is closer to the average at 14.8, only about 6.5% above the historical average of 13.9. And, yes, the dividend yield is below the norm, as well.
Add to this equation a stock price that is a hair’s breath away from its all time high and you start to see a picture of a stock with a valuation that appears to be a little, perhaps a lot, stretched.
Another name to be wary of
That makes PepsiCo just another in a long line of great companies with impressive histories and dividend records that investors are pushing to extreme valuations. The risk isn’t in the business, it’s in the valuation. There has been a stampede of money flowing to dividend-focused names like PepsiCo and that’s had the exact effect you would expect-higher stock prices.
Since trends like this don’t go on forever, this influx of cash is, at some point, likely to move on to another investment fad. And when that happens, PepsiCo’s valuation will fall… Even if PepsiCo the company continues to do relatively well.
I’m not suggesting that anyone who owns it should run out and sell PepsiCo. However, if you are looking at buying it, you might want to strongly consider the price tag you are paying. And if you do own it or buy it, be prepared for the dividend fad to end. It could get ugly quickly and lead PepsiCo’s shares lower. That would be a buying opportunity if you are prepared for it, but only if you don’t panic and sell.
Fuente: Seeking Alpha
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