BUY-rated, Focus-List selection PepsiCo Inc. (NGS: PEP) is a well-managed company with a valuable brand portfolio, and continues to generate solid growth amid weak demand for many consumer staples. Despite fewer orders from restaurants, theaters and stadiums, PepsiCo reported strong 3Q20 revenue, topping the consensus revenue estimate by $900 million. We expect cost cutting to continue to benefit earnings, and look for PepsiCo to achieve its goal of $1 billion in annual cost savings and productivity gains through 2023. Initiatives include optimizing the company’s global manufacturing footprint and reengineering its distribution network.
Our target price of $164, combined with the dividend, implies a total potential return of approximately 21% from current levels.
RECENT DEVELOPMENTS
On October 1, PepsiCo reported third-quarter revenue of $18.1 billion, up 5.3% from 3Q19 and above the consensus estimate of $17.2 billion. Organic revenue rose 420 basis points, driven by a 6% increase at Frito Lay North America (above the consensus estimate of 5%) and 6% growth at Quaker Foods North America (in line with the consensus estimate).In Europe, same-store sales rose 7%. In 3Q20, PepsiCo’s adjusted gross margin decreased 60 basis points to 54.8%. The decline in the operating margin reflects nearly $150 million in COVID-19 related costs. Adjusted operating income increased by $84 million, to $3.04 billion. GAAP EPS rose to $1.65 from $1.49 a year earlier. Revenue has topped consensus estimates in 19 of the past 23 quarters. Earnings have been above consensus in 25 of the past 27 quarters and met expectations in the other two quarters. Interest expense rose to $264 million from $224 million, while the share count declined modestly, to just over 1.39 billion.
EPS was $5.53, down from $5.65 in 2018. Organic revenue grew a very healthy 4.5%, indicating that management’s plan to increase organic growth is working.
EARNINGS & GROWTH ANALYSIS
Also expects to return $10 billion in cash to shareholders and free cash flow of $6 billion which reflects $4 billion in capital spending.
Looking ahead, we expect foreign exchange headwinds, fewer sales to restaurants, stadiums and theaters, and additional business investments to limit earnings growth this year.
FINANCIAL STRENGTH & DIVIDEND
The company ended 3Q20 with $9.7 billion in cash and short-term investments, up from $5.7 billion.
The shares are included in the S&P Dividend Aristocrat Index.
RISKS
Pepsi faces challenges from rising costs for commodities and other inputs. Although the company has implemented price increases across its portfolio, it has not been able to fully offset inflation. We note that Pepsi, which sells both food and beverages, is more exposed to agricultural cost inflation than Coca-Cola, which does not have food operations.
COMPANY DESCRIPTION
PepsiCo, founded in 1898, produces and sells food, snacks, and beverages around the world. The company’s brands include Lay’s, Ruffles, Doritos, Tostitos, Cheetos, Quaker Oatmeal, and Rice-A-Roni; its beverage portfolio includes Pepsi, Mountain Dew, Gatorade, 7UP, Tropicana, and various bottled water products. On average, 11 of the 15 top-selling products in convenience stores come from PepsiCo, and Lay’s is the world’s best-selling snack food brand, having expanded sales from $100 million fifty years ago to $30 billion today. The company also provides tea and coffee products through a joint venture with Starbucks and Unilever.
VALUATION
The shares were up 1.3% on October 1 as a result of higher-than-anticipated revenue, organic revenue growth and earnings. We think prospects for ongoing dividends, share buybacks and strong earnings amid a slowing economy warrant a higher multiple for the shares. In line with the five-year average, while its price/free cash flow ratio is 26.5. Based on our analysis and the potential for positive earnings surprises, we calculate a fair value of $164 per share.
