PepsiCo: New CEO Aims for "Faster, Stronger and Better"

04/15/2019 5:00 am EST

Focus: CONSUMER

Garrett Nelson

Senior Equity Research Analyst, CFRA, Equity and Fund Research

Our latest Focus Stock is PepsiCo (PEP), which carries CFRA's highest recommendation of 5-STARS, or Strong Buy. PepsiCo is a global leader in the snack and beverage industry, notes Garrett Nelson, and analyst with CFRA Research's The Outlook.

We view PEP as a high-quality, large-cap value/income name that has been proactively investing in faster-growing healthier beverage and snack products to offset declining carbonated soft drink consumption.

In 2018, PepsiCo's U.S. operations generated 57% of total net revenue and its international operations 43% (with Mexico, Russia, Canada, the U.K. and Brazil together accounting for 20% of net revenue). We like the stock for several reasons at current levels, as discussed below.

We particularly like PEP's Frito-Lay North America segment (25% of revenues and 44% of operating profit in 2018), which is growing at a healthy pace and helping offset challenges in soft drink demand.

This gives PepsiCo a degree of diversification that its beverage-only focused rival, The Coca-Cola Company (KO), lacks. PepsiCo is also more U.S. focused than Coca-Cola (international operations account for 43% of total revenues for PEP versus 64% for KO), which we view positively given present headwinds from U.S. dollar strength.

Last year, PEP's largest beverage segment (North American Beverage) posted a 3% drop in carbonated soft drink volumes (down from a 1% decline in 2017), as consumers continue to shift toward healthier, lower-calorie and less sugary beverages and snacks. Despite the volume drop, PEP's segment net revenue grew 1%, as non-carbonated beverage volumes increased 2% and price realizations improved.

New chairman and CEO Ramon Laguarta could set more ambitious growth targets than his recently-retired predecessor. Laguarta took over from Indra Nooyi, who had served as CEO for the past 12 years, last October. In keeping with past practice, Pepsi promoted internally to fill the role, as Laguarta had been with the company for 22 years and previously served as CEO of the company's Europe and Sub-Saharan Africa region.

Laguarta said he is focused on opportunities to make the company, "Faster, stronger and better." We also think PEP could turn more shareholder friendly, noting that already under Laguarta's leadership, the company announced a 50% increase in planned share repurchases relative to FY 18 levels.

PepsiCo recently announced an increase in expected cash returns to shareholders of $8 billion in FY 19 ($5 billion of dividends / $3 billion of share repurchases), an increase from $6.93 billion in FY 18 ($4.93 billion of dividends / $2.0 billion of share repurchases).

PEP recently announced a dividend increase to $3.82/share annualized effective with the June dividend payment, which equates to a nearly 10-year high dividend yield of 3.5% and we think reflects confidence in its near and intermediate-term prospects. The dividend hike represented PEP's 47th consecutive annual dividend increase.

Looking at estimates and valuation, CFRA estimates the company's adjusted EPS will go from $5.23 in 2017 and $5.66 in 2018 to $5.60 in 2019 and $6.00 in 2020. The pause in EPS growth in 2019 primarily reflects expectations for a higher effective tax rate (21% versus 18.8% in FY 18) and should be temporary, as PEP is targeting long-term organic revenue growth of 4-6%, core operating margin expansion of 20-30 bps, and high single-digit EPS growth (constant currency).

Our 12-month target price of $128 implies a 2020 P/E multiple of 21.3x, about in line with the average of packaged food and beverage peers. We think PEP's current multiples undervalue its ongoing diversification into higher-growth products and markets.

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