Analyst:
Shane Connor
937-657-7371
connor.87@osu.edu
PepsiCo, Inc.
Recommending: Buy
NYSE-PEP
August 18, 2009
Beverages
Investment Conclusion-BUY
PEP-BUY
Current Price
1-year Price Target
52 Week Range
Market Cap
Diluted Shares Outstanding
Average Daily Volume
Dividend
Yield
Consensus
High
Low
SIM Est.
FW P/E Ratio
*2008 average
2008A
3.21
Key Points:
•
3.1%
20.1x*
2009E
3.70
3.80
3.65
3.76
15x
2010E
4.07
4.16
3.91
4.00
14.1x
43,251
2.33*
2009E
44,361
1.98
2010E
48,057
1.85
(in millions)
FY Sales Est.
Price Sales
$56.56
$70.04
$43.78-75.25
88,800m
1,570m
9.86m
PepsiCo’s shares are currently undervalued
at 14.8x 2009 EPS. Declining commodity
costs, strong international sales, and FritoLay should drive earnings. Bottler
integration should be seen as a major
positive for Pepsi Americas Beverages.
.
•
As the economy recovers, demand
should pick up across all business
segments.
Strong international growth will continue
as PepsiCo leverages its brands and
marketing power.
•
Frito-Lay revenue should continue to
grow as PepsiCo offers more value to
consumer than private labels.
•
Concerns over declining demand for
carbonated soda beverages are
overstated. Bottler integration should put
PepsiCo is the driver’s seat.
•
Since PepsiCo successfully operates
many of its international bottlers, shareholders should be confident in the
company’s ability to run U.S bottling
operations.
Company Profile1:
PepsiCo's beverage business was founded in 1898 by Caleb Bradham, the pharmacist
who first formulated Pepsi-Cola. PepsiCo, Inc. was founded in 1965 when Pepsi-Cola
and Frito-Lay merged. Today, PepsiCo (PEP) manufactures, markets, and sells a
variety of salty, convenient, sweet, and grain-based snacks; carbonated and noncarbonated beverages; and foods in approximately 200 countries. Their largest
operations are found in North America (United States and Canada), Mexico, and the
United Kingdom. PepsiCo currently has six business segments: Frito Lay North America
(FLNA); Quaker Foods North America (QFNA); Latin America Foods (LAF); Pepsi
Americas Beverages (PAB); United Kingdom & Europe (UKEU); and, Middle East,
Africa & Asia (MEAA).
Business Segments2:
Frito-Lay North America (FLNA: 29% of 2008 revenue)
FLNA manufactures, markets, sells, and distributes branded snacks to independent
distributors and retailers. Major brands include: Lay’s®, Doritos®, Tostitos®, Cheetos®,
Fritos®, Ruffles®, Rold Gold®, Sunchips®, Grandma’s®, Cracker Jack®, Smartfood ®,
TrueNorth™, and several others totaling almost 400 different products within these
brands. FLNA comprised 37% of PepsiCo’s 2008 operating profits, the highest of the six
business segments.
Pepsi Americas Beverages (PAB: 25% of 2008 revenue)
PAB consists of brands which produce carbonated soft drinks, juices and juice drinks,
ready-to-drink teas and coffee drinks, isotonic sports drinks, bottled water and
enhanced waters. Major brands distributed by this business segment include Pepsi,
Mountain Dew, Gatorade, Tropicana, Sierra Mist, Mirinda, Propel, Dole, Amp, SoBe,
Naked, and Izze. PAB comprised 26% of PepsiCo’s 2008 operating profits.
1
2
2008 10-K
2008 10-K
2
UK & Europe (UKEU: 15% of 2008 revenue)
The UK & Europe segment of PepsiCo manufactures, markets, and sells both snacks
and beverages. In addition to Frito-Lay brands, PepsiCo also owns European-specific
brands. The most dominant is Walkers®, the leading salty snack brand by market share
in the United Kingdom. PepsiCo sells most of its domestic beverages plus a few
European-specific beverage brands. Last March, PepsiCo acquired 75% of Russian
juice maker Lebedyansky®. PepsiCo stated Lebedyansky® production volumes grew 30fold from 1999 to 2007 and quadrupled market share in the same period. Unlike U.S.
PepsiCo, the UK and European business segment has operated most of its bottlers and
distributors for many years. UKEU comprised 10% of PepsiCo’s 2008 operating profit.
Latin America Foods (LAF: 14% of 2008 revenues)
LAF manufactures, markets, and sells both salty and sweet snacks under many of same
Frito-Lay North America brand names. LAF PepsiCo uses contracted distributors and
manufacturers for its Quaker brands distribution. Pepsi also owns popular Gamesa®
and Sabritas®, snack companies which hold significant market share in Latin America.
LAF comprised 11% of PepsiCo’s 2008 operating profit.
Middle East, Africa, and Asia (MEAA: 13% of 2008 revenue)
PepsiCo MEAA markets and sells PepsiCo’s branded snacks and cereals. These
products are sold to consolidated businesses and non-controlled affiliates. In addition,
PepsiCo MEAA markets and sells its beverages to authorized bottlers, independent
distributors, and retailers. Similar to UKEU, PepsiCo MEAA owns and operates many of
its bottlers and distributors. MEAA comprised 9% of PepsiCo’s 2008 operating profit.
Quaker Foods North America (QFNA: 4% of revenue)
QFNA manufactures (or uses contract manufacturers), markets, and sells cereals, rice,
pasta and other branded products. QFNA’s products include: Quaker Oats®, Life® and
Cap N’ Crunch® cereals, Aunt Jemima® syrups, and Rice-A-Roni®. These products are
sold through distributors and retailers. QFNA comprised 7% of PepsiCo’s 2008
revenues.
3
Figure 1
PepsiCo’s Major Name Brands
4
Macro Economic Factors
Figures 2.1, 2.2, 2.3
PepsiCo is part of the consumer staples
PEP Revenue Line Fit Plot
sector – which tends to perform well even
when the country is viewed to be in a
U.S. is returning to growth and positive
GDP
recession. Most economists agree the
GDP should be reported sometime later
this year. A recent Wall Street Journal
-10.00%
survey indicates many economists feel
0.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
-8.00%
10.00% 20.00%
GDP
Revnue
PEP Revenue
that GDP could turn positive as early as
this quarter. I believe PepsiCo will benefit
PepsiCo Line Fit Plot
from an improving macro picture and
GDP growth is an obvious positive
economic sign. I think PepsiCo will
GDP
lower commodity costs.
undoubtedly benefit from this growth. To
understand the extent of PepsiCo’s
-2.0%
0.0%
2.0%
4.0%
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
-8.00%
6.0%
GDP
PepsiCo
Volume
PepsiCo
correlation with the GDP, I ran a series of
regressions. The sample size was comprised of the past ten quarters. I chose this
sample to determine how PepsiCo is performing in the current environment. First, I ran
a regression comparing GDP and
PAB Line Fit Plot
PepsiCo revenues. The correlation was
Next, I ran regressions using volume as
this excludes price increases and foreign
exchange. My results were surprising.
GDP and PepsiCo volume growth
showed a correlation of .84. I thought this
GDP
positive, but was not very strong (.64).
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
-8.00%
-8.0 -6.0 -4.0 -2.0 0.0% 2.0% 4.0%
%
%
%
%
GDP
PAB
Volume
PAB
quite high considering PepsiCo is
regarded as a consumer staple.
5
Lastly, I ran a regression comparing GDP and PAB volume growth. I did this as I
believe PAB is not only struggling due to increased competition in the beverage
industry, but also due to a macro slowdown. The correlation between GDP and PAB
volume was .87. This supports my conclusion that PAB problems can also be attributed
to the economy.
Figure 4
GDP
GDP
PEP Revenue
PepsiCo Volume
PAB Volume
PEP Revenue
1
0.643959678
0.837758933
0.867067187
PepsiCo Volume
1
0.88213954
0.805432412
1
0.923542917
PAB Volume
1
PepsiCo will benefit from the fall in commodity prices in the latter part of 2008.
No commodity represents more than 10% of PepsiCo’s COGS, but together they
represent a significant portion. PepsiCo enters into futures contracts in order to hedge
themselves against commodity prices. During conference calls, management indicated
many of these contracts were entered into last summer. I believe PepsiCo will benefit
when these contracts expire and they will be able to enter into new contracts at much
lower prices. Figure 5 shows the significant drop off in commodity prices since last year.
Figure 5 (Source USDA)
6
Overall, PepsiCo’s input costs should decrease in the second half of this year. I
believe food commodity prices should remain low as the supply side reports good
outputs. According to the USDA, estimated corn crop production is 12.761 billion
bushels. Providing this estimate is accurate, it would be the second largest recorded
corn crop. Continued low commodity costs will increase PepsiCo’s margins.
Sector Outlook
Consumer Staples have underperformed the S&P 500 by 8% YTD. Much of this can be
attributed to investors moving funds out of defensive sectors and into more cyclical
sectors. Investors are more willing to take on risk in anticipation of an economic
recovery. In Figure 6 different valuation metrics are shown on an absolute basis.
Figure 6
Absolute Basis High
P/Trailing E
P/Forward E
P/B
P/S
P/CF
Low
20.8
19.2
5.2
1.3
14.5
Median
12.2
12.1
2.6
0.6
8.8
Current
18.9
17.9
4.5
1
13.3
Analyst Opinion
14.2 Undervalued
13.8 Undervalued
3.3 Undervalued
0.7 Undervalued
10.3 Undervalued
Source: Thompson Baseline
Currently, all of the valuation metrics seem to undervalue consumer staples. This
can be expected due to the recent movement to more cyclical sectors.
In Figure 7 the same valuation metrics are shown relative to the S&P 500. This
shows that Consumer Staples appear to be more inline with historical valuation.
Figure 7
Relative to
SP500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
1.2
1.3
2
0.9
1.4
Median
0.94
0.86
1.4
0.6
1
Current
1.1
1.1
1.7
0.7
1.3
Analyst Opinion
0.96 Undervalued
0.89 Undervalued
1.6 Inline
0.8 Inline
1.2 Inline
Source: Thompson Baseline
7
In conclusion, I think Consumer Staples are a necessary part of any portfolio
given current uncertainty in equity markets. Consumer Staples could also perform very
well in a growing global economy as emerging markets begin to spend money on more
on staples. The beverages industry is a good example of an industry which could
benefit from a growing global economy.
Figure 8 (Source: S&P industry survey)
Beverages Industry
Historically, the beverages
industry has been one of the
more cyclical industries
within Consumer Staples. It
trades at higher valuation
multiples since beverage
companies offer more
growth than most other
Consumer Staples. A major concern for the industry is declining demand for carbonated
soft drinks (CSDs). Consumers have been opting for healthier options such as water
and energy boosting drinks.
Figure 8 shows CSDs consumption declined 3.1% in 2008 compared to 2007.
Flavored and enhanced water and energy drinks had the greatest gains. This data
appears to confirm a consumer shift from CSDs. If the trend continues, beverage
companies will be forced to come up with innovative new products to spur demand.
A major risk for the beverage industry is the proposed soda tax. Lawmakers are
debating the idea of a soda tax to help pay for healthcare reform. Early reports indicate
the tax could be as much as three cents per twelve ounces. Currently, the soda tax is
simply one of a hundred different ideas to pay for healthcare reform. However, if
passed, it would constitute a major disadvantage to the beverages industry.
8
Company Analysis
“The Deal”
On August 4, 2009, PepsiCo struck a deal to buy its two largest bottlers. The acquisition
of Pepsi Bottling Group and Pepsi Americas will give PepsiCo control of 80% of its U.S.
beverage distribution. The deal will cost PepsiCo $7.8bn and shareholders will have the
option to choose cash or PepsiCo stock. This may be confusing to some as ten years
ago PepsiCo completed a spin-off of these two companies.
In 1999, PepsiCo divested it two largest bottlers but continued to hold minority
shares in both. PepsiCo felt this would increase shareholder value as profits came
primarily from fountain beverages and concentrated sales. PepsiCo believed bottling
was too capital intensive and the margins were not large enough. After the divestiture,
PepsiCo’s operating margins and ROIC increased. Coke followed Pepsi’s lead and
divested its bottlers as well.
However, the beverage industry went through a change the years after the spin
off. There were new small “niche” companies (vitamin water), more juices, teas, and
energy drinks entering the market. In addition, CSD (carbonated soft drink) demand was
weakening as consumers looked for healthier alternatives. PepsiCo responded by
developing healthy alternatives, but often lagged behind in bringing these products to
market. The lag was caused by bottlers who relied on heavy volumes to make a profit
and did not want to experiment with “niche” products. Without a competitive presence
from PepsiCo or Coke, many companies easily entered the industry and were able to
carve out significant market share.
PepsiCo quickly realized that in order to grow in the beverage industry it would
need to offer new products. An initial offer of $6bn by PepsiCo was turned down by the
bottlers. Pepsi Bottling Group stated the deal undervalued the potential $750-$850
million in synergies. In the initial offer PepsiCo estimated synergies of only $200 million.
PepsiCo now says that there should be $250 million in synergies.
Is this a positive?
Only time will tell, but I believe bottler integration is necessary to grow PAB (Pepsi
Americas Beverages).
9
Benefits
•
PepsiCo, through Frito-Lay, has many of the same distribution channels as its
bottlers
•
Duplicate jobs can be eliminated
•
PepsiCo can now experiment with “niche” products and package innovation
•
Integration should improve PepsiCo’s ability in bring new products to market
•
PepsiCo may be able to offer bundled items
•
Gatorade and Aquafina water 24pk
Risks
•
Unanticipated charges or poor performance relating to the integration and operation
of Pepsi Bottling Group and Pepsi Americas
•
PepsiCo has owned its international bottlers since it expanded to those markets.
I believe PepsiCo should be able to leverage this operational knowledge to
efficiently integrate and operate its U.S. operations
Figure 93
Business Segment Analysis
Frito-Lay North America (FLNA) Analysis
PepsiCo holds a 39% market share in the
U.S. savory food snacks market4. In the last
three years FLNA has delivered high single
digit revenue growth and low single digit
volume growth. In mid-2008, PepsiCo
passed price increases through to
consumers due to higher commodity costs.
Subsequently, revenue continued to grow
but volume decreased as the economy
3
4
Company Reports
Company Reports
10
weakened and consumers traded down to private labels. In 2009, PepsiCo has pulled
back somewhat on the price increases they implemented in 2008, and have introduced
the “20% more” campaign promoting more chips per bag. Consumers were quick to
recognize the added value as FLNA reported a 3% volume growth and more than an
8% revenue growth in 2Q09. I believe this is PepsiCo’s most important business
segment. Brands such as Frito-Lay, Doritos, and Ruffles are household names which
offer strong, predictable demand. PepsiCo distributes these products through its Direct
Store Delivery (DSD) network – a system that delivers Frito-Lay products directly to
retailers. PepsiCo works with individual retailers to improve inventory management and
reduce costs. This unique relationship is a best-in-industry practice that PepsiCo should
be able to effectively leverage when they begin distributing their own beverages.
Pepsi Americas Beverages (PAB) Analysis
Figure 105
PAB is often perceived as PepsiCo’s
“problem child” due to decreasing sales
volume. These declines can be primarily
attributed to a more health conscious
consumer and increased competition in the
beverages space. Health conscious
consumers have been gravitating more
towards water, low calorie beverages, teas,
and juices. PepsiCo has responded by
introducing low calorie alternatives as well
as by acquiring smaller beverage
companies (i.e. Naked Juices) that
compete in this space.
A secondary reason for volume
decline is increased competition in the beverage industry. The industry now includes
several niche products – e.g., energy drinks, enhanced waters, teas, and specialty
5
Company Reports
11
juices. PepsiCo has tried to bring similar products to market, but has not been very
successful. Forestalling their efforts was their relationships with the bottlers who rely on
large volume production that niche products generally cannot deliver. I believe
PepsiCo’s recently announced acquisition of the Pepsi Bottling Group and Pepsi
Americas will enable them to restore long term growth in this segment.
Within Pepsi American Beverages the Gatorade product has struggled most,
down an estimated -18%6 in second quarter volume. Gatorade is a premium priced
product which depends on consumer activity. During the second quarter conference call
CEO Indra Nooyi noted construction workers were no longer buying multiple bottles of
Gatorade on the way to work as they did prior to the recession. This is a good example
of the product’s dependence on consumer activity. Furthermore, with high
unemployment, premium priced products like Gatorade tend to struggle.
PepsiCo recently rebranded Gatorade as “G”. Initial reactions have been mixed
but PepsiCo has stated this is a long term strategy. In addition, I believe Gatorade or
“G” will be one of the benefactors of the bottler’s integration. PepsiCo will be able to
bring to market more flavors, bottle sizes, and bottle styles. Overall, I think Gatorade’s
weakness will be short lived. As consumer activity recovers and new products come to
market, Gatorade will return to strong growth.
United Kingdom & Europe (UKEU) Analysis
In 2008, snack volume was up 6% compared to the previous year. Walkers® had low
single digit volume increases in most regions and acquisitions added to the volume
increase. UKEU beverage volume was up 17% compared to the previous year. Newly
acquired Lebedyansky® contributed 16% growth and carbonated soft drinks achieved
modest volume gains.
These results clearly illustrate the international growth PepsiCo is experiencing. I
believe PepsiCo is unfairly classified as a mature company. PepsiCo investors receive
consistent domestic performance, but are also exposed to PepsiCo’s growing
international franchise.
6
Beverage Digest
12
PepsiCo is committed to international growth both organically and though
acquisitions. Pricing, brand recognition, and distribution power enable PepsiCo to enter
new markets and immediately become the leader. I believe UKEU will continue to
outpace other segments as PepsiCo enters fast growing emerging markets where
population and growth are increasing.
Latin American Foods (LAF) Analysis
The LAF business is currently experiencing slower growth than MEAA and UKEU
because PepsiCo been in the LAF market much longer. This segment reported a 3%
increase in volume, primarily coming from an acquisition in Brazil. Mid single digit
declines for Sabritas® was offset by mid single digit increases for Gamesa®. I believe
PepsiCo has less room for distribution growth than it once had and as a result will now
focus on small acquisition growth, new product offerings, and market growth. For
example, PepsiCo announced this month it was acquiring Brazil’s top coconut water
company.
Middle East, Africa, and Asia (MEAA) Analysis
MEAA is PepsiCo’s fastest growing segment. Double digit volume growth has been
recorded in the past three years. In 2008, double digit and mid digit growth was
recorded by China and India, respectively. PepsiCo’s expansion into these markets
came much later than rival Coke; however, PepsiCo’s brands have been very well
received. This relative underexposure will allow PepsiCo to increase market share by
simply increasing distribution. Further growth will come as acquisitions are made and
brand awareness increases.
Quaker Foods North America (QFNA) Analysis
Although QFNA is PepsiCo’s smallest segment by revenue, it is a stable performer. In
2008, QFNA reported a 1.5% volume decline compared to the previous year. This was
13
largely due to lower sales of Quaker Oatmeal and ready-to-eat cereals. This segment is
not as susceptible to major volume swings and seems to chug right along without much
attention. PepsiCo is more concentrated on its international growth businesses than
QFNA. I believe QFNA has serious potential and could be one of the only segments that
can take advantage of a more health conscious consumer. New product offerings under
a powerful brand name like Quaker would be very successful.
It’s not just a battle over taste…
PepsiCo (PEP) vs. Coke (KO)
The battle between Pepsi and Coke is not just over taste but also over investor dollars.
When building a portfolio, investors and portfolio managers must determine which
company offers better value. For example, when PepsiCo reports its earnings, Coke
must either match or beat Pepsi’s earnings and vice versa. If either falls short, it often
times negatively impacts their stock price. This is a fairly unique situation as there are
very few industries where such large market shares are at stake. In Figure 11, I have
determined who is better positioned for long term success.
14
Figure 11
Battle Grounds
Pepsi
Coke
15.1x
16.1x
36.20%
27.20%
2.7x
3.6x
3.05%
3.60%
Forward P/E
ROE
P/S
Dividend Yield
Efficiency
Product Diversification
International Exposure
Inventory Turnover- 7.8,
Asset Turnover 1.2,
Average Collection
Period (days)- 37.8
PepsiCo has stong
snack, food, and
beverage brands. Its
strongest brands might
be in snacks (Frito-Lay)
International sales are
approximately 40% of
revenues
Advantage
Inventory Turnover4.7, Asset Turnover.76, Average Collection
Period (days)- 36.1
Coke is strictly
beverages
International sales are
approximately 70% of
revenues
WINNER
Source: S&P Data Insight (OSU Libraries)
15
Income Statement and Segment Revenue
(Appendix 1,2)
PepsiCo’s revenue over the last five years has been growing at a compounded annual
growth rate of 10.4%. This impressive performance has been mainly driven by organic
growth not acquisitions. (PepsiCo’s last major acquisition was Quaker Oats in 2001)
Going forward, I forecasted 2.57%, 8.33%, and 7.58% revenue growth in years 2009,
2010 and 2011, respectively. Company guidance for 2009 was 6-9% revenue growth
excluding currency. In the second quarter, PepsiCo stated that 2009 revenue would be
negatively affected by currency due to the strong dollar in the first half of the year.
Therefore, I believe that my forecast (2.57%) is within reason.
Operating margins should move higher in 2009 as PepsiCo’s existing commodity
contracts expire. This should boost operating margins in the second half of this year.
These effects are taken into account on a per segments basis in my forecasts.
Balance Sheet Analysis
(Appendix 4)
After analyzing the balance sheet no major red flags were found. The big jump in debt
from 2007 to 2008 could be attributed to the anticipated acquisition of Pepsi Bottling
Group and Pepsi Americas. Other acquisitions in 2008 (Lebedyansky) were also funded
partially though debt. I believe debt should not be a concern as PepsiCo sill maintains a
Net debt/EBITDA ratio of .6. PepsiCo is also able to borrow at very attractive rates given
their A+ S&P rating.
16
Valuation Analysis
I utilized three different valuation techniques to determine a price target for PepsiCo
(PEP): (1) Discounted Cash Flow model; (2) Historical valuation multiple model; and (3)
Forward EPS estimate.
(1) DCF Valuation (Appendix 3)
Assumptions
•
10% discount rate used, which is relatively high for a consumer staple
•
3.5% terminal growth as it represents historical GDP
•
Long term revenue growth remains around 8% due to strong international demand; it
eventually reverts back to 3.5% terminal rate
•
17.5 % operating margin represents the 5 years average
•
3.8 % depreciation and amortization represents historical average
•
Working capital gradually decreases as revenue growth slows
I came up with an intrinsic value of $72.82 using the discounted cash flow model.
Additionally, I performed a sensitivity analysis to determine the effects of using different
discount rates and terminal growth rates.
Figure 12
Sensitivity Analysis- Implied Equity Value ($)
Terminal Discount Rate
Terminal FCF
9.00%
9.50%
3.00%
82.08
75.35
3.50%
86.92
79.28
4.00%
92.72
83.92
4.50%
99.82
89.49
5.00%
108.69
96.30
Sensitivity Analysis- Upside (%)
Terminal Discount Rate
Terminal FCF
9.00%
9.50%
3.00%
45.1%
33.2%
3.50%
53.7%
40.2%
4.00%
63.9%
48.4%
4.50%
76.5%
58.2%
5.00%
92.2%
70.3%
10.00%
69.59
72.82
76.59
81.05
86.40
10.50%
64.60
67.29
70.40
74.02
78.30
11.00%
60.25
62.51
65.10
68.08
71.55
11.50%
56.55
58.34
60.51
62.99
65.85
12.00%
53.02
54.66
56.50
58.58
60.97
12.50%
49.99
51.39
52.97
54.73
56.74
10.00%
23.0%
28.7%
35.4%
43.3%
52.8%
10.50%
14.2%
19.0%
24.5%
30.9%
38.4%
11.00%
6.5%
10.5%
15.1%
20.4%
26.5%
11.50%
0.0%
3.1%
7.0%
11.4%
16.4%
12.00%
-6.3%
-3.4%
-0.1%
3.6%
7.8%
12.50%
-11.6%
-9.1%
-6.3%
-3.2%
0.3%
17
The results (Figure 12) show the downside risk is not present until a 12%
discount rate is used. I believe my 10% rate is very conservative and should provide a
good margin of safety. When I determined my discount rate I started at a rate of 9%. I
then added 50 bps for risks associated with the bottler integration. I also added an
additional 50bps for risks associated with a declining beverage demand. A 10%
discount rate is much higher than the rate the CAPM determined.
(2) Comparable Valuation Multiple Model
From the comparable valuation multiple model analysis I determined the value of PEP is
$67.31. This results in a 21% upside from the PEP’s current share price. I arrived at
this price by averaging the target multiples for each valuation metric. I tried to show
mean reversion when choosing my target multiples. I also considered the various risk
and rewards associated with PepsiCo. Additionally, as the economy recovers and
investors move back into the market, multiples will gradually increase. I feel these
multiples are realistic over a one year time period.
Figure 13
Absolute High
Valuation
A.
P/Forward
E
P/S
P/B
P/EBITDA
P/CF
Average
Low
Median Current Target E, S, B, Target
Multiple etc/Share Price
B.
22.7
C.
13.1
D.
19.8
E.
14.8
F.
17.5
G.
3.76
H.
$65.80
3.5
7.7
14.72
1.8
5.5
8.55
3.1
6.7
12.61
2.1
7.4
9.2
2.5
7.2
10.5
32.47
7.74
6.22
$81.71
$55.71
$65.31
19.6
10.4
17.1
12.2
13
4.69
$68.00
$67.31
As of 8/3/09 Source: Thompson Baseline
(3) Forward Price/Earnings
18
Finally, I wanted to come up with a value for PEP that would include the bottler
integration. PepsiCo stated the bottler integration would result in $250 million in
synergies and be .15c accretive to EPS by 2012. I feel synergies will be greater and
occur sooner than stated. (Pepsi Bottling Group said there was $750-$850 in
synergies.) However, I cannot blame PepsiCo for being conservative given integration
uncertainty. I arrived at my target price of $70.53 by adding .10c onto my 2010 EPS and
applying a 17.5x P/E multiple. This price target should be included in my 1- year target
since investors will consider PepsiCo’s future earning power.
Figure 14
Forward Multiple Price Target
2010 EPS
Accretive EPS
2010 EPS
Target Multiple
$3.90
+
.10c
= $ 4.00 x
17.5x
Price Target
$
70.00
Valuation Recap
•
DCF price target: $72.82
•
Comparable Valuation Multiple Model: $67.31
•
Forward Price/Earnings: $70.00
I averaged all three price targets to arrive at a one year of $70.04. The implied upside
for using this price tag and adding in the dividend yield is 27%.
Risks to Price Target
•
Unanticipated charges relating to the integration of Pepsi Bottling Group and Pepsi
Americas
•
Continued weak demand for carbonated soft drinks
•
Enactment of soda tax
•
Foreign Currency and commodity price volatility
19
Executive Summary
•
I am assigning a BUY rating with a $70.04 1-year target price.
•
This target price implies 27% upside including the dividend.
I believe PepsiCo’s shares are currently undervalued and will offer good, long
term appreciation. PepsiCo currently trades at 14.8x my 2009 EPS estimates. This
represents a 34% discount compared to their historical forward P/E of 19.8x. In addition,
PepsiCo’s Price/Sales, Price/EBITDA, and Price/Cash Flow all trade at a discount to
their respective historical medians. My DCF model values PepsiCo’s shares at $72.58
which implies an upside of 28%. I included all risk factors, consumer trends, and macro
economic factors when generating forecasts. My estimates are conservative and
earnings upside is very possible. Some may argue current valuation is warranted given
the weak demand for soft drinks. However, I perceive this concern to be overstated and
believe bottler integration within PAB will mark a turning point for this business segment.
Short term projections: PepsiCo will benefit from a macro recovery. My
research shows a positive correlation between PepsiCo’s volume and the GDP.
Therefore, as GDP begins to rebound, PepsiCo’s volume should pick up.
PepsiCo will also benefit from lower commodity costs. I anticipate this margin
expansion to occur in the second half of this year as previous commodity contracts
expire and PepsiCo is in a position to renegotiate them at lower prices.
PepsiCo remains an attractive investment despite the record rally from March
lows. Since March, the S&P 500 is up almost 50%, but PepsiCo is up only 9%. PepsiCo
is well positioned, therefore, to be a beneficiary as investors hunt for remaining
bargains.
Long term projections: A majority of PepsiCo’s growth will come from two
sources: (1) international growth and correlating market penetration, (2) Pepsi Americas
Beverages, and (3) Frito-Lay North America
20
PepsiCo’s low international exposure relative to Coke is as an opportunity for the
company to aggressively expand and grow international sales by leveraging its brands
and marketing power. In addition, international acquisitions, e.g., Lebedyansky, and
market penetration, especially in the MEAA business segment, should offer long term
growth.
Pepsi Americas Beverages will become a long term growth vehicle for the
company. After the acquisition of Pepsi Bottling Group and Pepsi Americas, PepsiCo
will be on course to level the playing field with its smaller “niche” competitors. PepsiCo
will have the ability to develop and produce products that can go head-to-head with
these competitors who have been eroding market share.
Frito-Lay growth should continue as PepsiCo is able to leverage its dominant
brand names. Private label penetration has been a concern but PepsiCo has regained
the upper hand by offer “20% more per bag”. This campaign should not significantly cut
into PepsiCo’s margins because of lower commodity costs. In addition, price increases
implemented in 2008 will benefit PepsiCo.
Finally, I would not discount Quaker Foods North America (QFNA). If PepsiCo
targets the health conscious consumer and cleverly markets / leverages the popularity
of the brand as well as its products, this could be a business segment that brings
PepsiCo long term, sustainable growth.
21
Appendix 1
Pro Forma Income Statement
PepsiCo
Income Statement
Net Revenue
Cost of Sales
SG&A
Amort. of intangible
Segment Operating Profit
Corp- net impact of mark-mkt on
commodity hedges
Corp-Other
Operating Profit
Operating Profit Margin
Bottling equity income
Interest Exp.
Interest Inc
Income before Taxes
Provision for Taxes
Net Income
Net Income per Common Share
Basic w/o bottlers
Diluted w/o bottlers
Consensus
FY2011E
FY2010E
FY2009E
51,700
48,057
44,361
FY2008
43,251
FY2007
39,474
FY2006
35,137
FY2005
32,562
FY2004
29,261
9,561
9,154
8,436
7,942
7,923
7,240
6,764
6,098
-287
-905
8,370
-92
-841
8,222
295
-949
7,781
-346
-661
6,935
19
-772
7,170
-18
-720
6,502
-780
5,984
-839
5,259
16.19%
336.0
-439.45
77.55
8,344
2336.38
6,008
17.11%
312.4
-408.48
72.09
8,198
2295.34
5,902
17.54%
288.3
-399.25
66.54
7,737
1934.32
5,803
16.03%
374
-329
41
7,021
1879
5,142
18.16%
560
-224
125
7,631
1973
5,658
18.50%
553
-239
173
6,989
1347
5,642
18.38%
495
-256
159
6,382
2,304
4,078
17.97%
380
-167
74
5,546
1,372
4,174
4.07
4.04
3.93
3.90
4.333.90
3.80
3.76
3.803.60
3.26
2.21
3.48
3.41
3.42
3.34
2.45
2.41
2.45
2.41
22
Appendix 2
Segment Revenue and Operating Profit
PepsiCo Americas Foods
Frito-Lay North America
Quaker Foods North America
Latin America Foods
PepsiCo Americas Beverages
PepsiCo Americas Beverages
PepsiCo International
UK/Europe
Middle East/Africa/Asia
Total Revenue
FY2011E
FY2010E
FY2009E
FY2008
FY2007
FY2006
FY2005
15,318
1,979
6,644
14,588
1,959
6,095
13,508
1,921
5,541
12,507
1,902
5,895
11,586
1,860
4,872
10,844
1,769
3,972
10,322
1,718
11,022
10,598
10,390
10,937
11,090
10,362
8,551
8,186
7,635
7,181
6,757
6,244
6,435
5,575
5,492
4,574
4,750
3,440
9,146
11,376
-
51,700
48,057
44,361
43,251
39,474
35,137
32,562
3,676
604
1,096
3,574
637
1,006
3,309
586
887
2,959
582
897
2,845
568
714
2,615
554
655
2,529
537
-
PepsiCo
Segment Profit
PepsiCo Americas Foods
Frito-Lay North America
Quaker Foods North America
Latin America Foods
PepsiCo Americas Beverages
PepsiCo Americas Beverages
PepsiCo International
UK/Europe
Middle East/Africa/Asia
2,094
2,014
2,026
2,026
2,487
2,315
1,048
1,044
954
969
878
749
811
667
774
535
700
401
2,037
1,661
-
Operating Profit
9,561
9,154
8,436
7,942
7,923
7,240
6,764
5.00%
1.00%
9.00%
8.00%
2.00%
10.00%
8.00%
1.00%
-6.00%
7.95%
2.26%
21.00%
6.84%
5.14%
22.66%
5.06%
2.97%
-
7.97%
12.58%
-
4.00%
2.00%
-5.00%
-1.38%
7.03%
13.30%
12.00%
14.00%
13.00%
15.00%
5.00%
12.00%
17.17%
21.88%
15.62%
32.97%
-
10.02%
15.35%
-
7.58%
8.33%
2.57%
9.57%
12.34%
7.91%
11.28%
Sales Growth (YOY)
PepsiCo Americas Foods
Frito-Lay North America
Quaker Foods North America
Latin America Foods
PepsiCo Americas Beverages
PepsiCo Americas Beverages
PepsiCo International
UK/Europe
Middle East/Africa/Asia
Total Revenue
Guidance ex. Currency
Operating Margin
PepsiCo Americas Foods
Frito-Lay North America
Quaker Foods North America
Latin America Foods
PepsiCo Americas Beverages
PepsiCo Americas Beverages
PepsiCo International
UK/Europe
Middle East/Africa/Asia
Operating Profit
6-9%
24.00%
30.50%
16.50%
24.50%
32.50%
16.50%
24.50%
30.50%
16.00%
23.66%
30.60%
15.22%
24.56%
30.54%
14.66%
24.11%
31.32%
16.49%
24.50%
31.26%
-
19.00%
19.00%
19.50%
18.52%
22.43%
22.34%
12.25%
12.75%
12.50%
13.50%
13.00%
12.00%
12.60%
11.96%
14.09%
11.70%
14.74%
11.66%
22.27%
14.60%
-
18.49%
19.05%
19.02%
18.36%
20.07%
20.61%
20.77%
23
7,781
17.54%
Operating Income
Operating Margin
72.82
Implied equity value/share
Upside/(Downside) to DCF
28.7%
56.56
1,570
$47,461.7
$66,864.9
114,326.6
4.52%
5,163
42%
58%
5,377
4%
1,802
3.75%
(110)
-0.23%
2,218
4.62%
5,902
2%
5,803
1,664
3.75%
(204)
-0.46%
2,100
4.73%
312.4
0.65%
2,295
27.9%
1,934
24.9%
288.3
0.65%
336
0.70%
333
0.75%
Current Price
Shares Outstanding
NPV of free cash flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
Free Cash Flow
YOY growth
Add Depreciation/Amort
% of Sales
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
Net Income
% Growth
Bottling Equity Income
% sales
Taxes
Tax Rate
Interest and Other- net
Interest % of Sales
48,057
8.33%
44,361
Revenue
% Growth
8,222
17.11%
2010E
2009E
Year
DCF Valuation
8/16/2009
Ticker: PEP
SHANE CONNOR
24
5,199
-3%
1,939
3.75%
(105)
-0.20%
2,643
5.11%
6,008
2%
336.0
0.65%
2,336
27.9%
362
0.70%
8,370
16.19%
51,700
7.58%
2011E
6,890
33%
2,104
3.8%
(67)
-0.12%
2,805
5.0%
7,658
27%
339.1
0.90%
2,834
27.9%
337
0.60%
9,816
17.50%
56,094
8.50%
2012E
7,449
8%
2,282
3.8%
(73)
-0.12%
3,043
5.0%
8,283
8%
342.1
0.90%
3,075
27.9%
365
0.60%
10,651
17.50%
60,862
8.50%
2013E
Terminal Discount Rate =
Terminal FCF Growth =
8,145
9%
2,442
3.8%
(78)
-0.12%
3,061
4.7%
8,842
7%
345.2
0.90%
3,290
27.9%
391
0.60%
11,396
17.50%
65,123
7.00%
8,834
8%
2,613
3.8%
(84)
-0.12%
3,136
4.5%
9,440
7%
348.3
0.90%
3,521
27.9%
418
0.60%
12,194
17.50%
69,681
7.00%
Forecast
2014E
2015E
10.0%
3.5%
Appendix 3: DCF Model
9,080
3%
2,770
3.8%
(89)
-0.12%
3,324
4.5%
9,722
3%
351.4
0.90%
3,629
27.9%
443
0.60%
12,557
17.00%
73,862
6.00%
2016E
9,998
10%
2,936
3.8%
(94)
-0.12%
3,132
4.0%
10,288
6%
354.6
0.90%
3,846
27.9%
470
0.60%
13,310
17.00%
78,294
6.00%
2017E
10,484
5%
3,083
3.8%
(99)
-0.12%
3,288
4.0%
10,788
5%
357.8
0.90%
4,039
27.9%
493
0.60%
13,975
17.00%
82,208
5.00%
2018E
Terminal
P/E
EV/EBITDA
Free Cash Yield
10,892
4%
3,206
3.8%
(103)
-0.12%
3,420
4.0%
11,208
4%
361.0
0.90%
4,200
27.9%
513
0.60%
14,534
17.00%
85,497
4.00%
2019E
173,430.4
15.5
10.3
6.28%
Terminal
Value
Appendix 4 (Source: S&P Market Insight)
Current Balance Sheet
ANNUAL BALANCE SHEET
($ MILLIONS)
PEPSICO INC
700 Anderson Hill Rd
Purchase, NY 10577
Ticker: PEP
Fiscal Year: 12
SIC: 2080 (Beverages)
GICS: 30201030 (Soft Drinks)
S&P Long-Term Issuer Credit Rating: A+
S&P Short-Term Issuer Credit Rating: Extremely Strong (A1)
Latest Q
Jun09
ASSETS
Cash & Short-Term Investments
Net Receivables
Inventories
Prepaid Expenses
Other Current Assets
Total Current Assets
Gross Plant, Property & Equipment
Accumulated Depreciation
Net Plant, Property & Equipment
Investments at Equity
Other Investments
Intangibles
Deferred Charges
Other Assets
TOTAL ASSETS
LIABILITIES
Long Term Debt Due In One Year
Notes Payable
Accounts Payable
Taxes Payable
Accrued Expenses
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Deferred Taxes
Investment Tax Credit
Minority Interest
Other Liabilities
TOTAL LIABILITIES
EQUITY
Preferred Stock - Redeemable
Preferred Stock - Nonredeemable
Total Preferred Stock
Common Stock
Capital Surplus
Retained Earnings
Less: Treasury Stock
Common Equity
TOTAL EQUITY
TOTAL LIABILITIES & EQUITY
Dec08
Dec07
Dec06
Dec05
Dec04
2,424.000
2,277.000
2,481.000
5,223.000
4,683.000
4,389.000
2,952.000
2,522.000
2,290.000
NA
@CF
@CF
1,031.000
1,324.000
991.000
------------------ ------------------ -----------------11,630.000
10,806.000
10,151.000
2,822.000
4,882.000
3,725.000
3,261.000
1,926.000
1,693.000
@CF
@CF
657.000
618.000
------------------ -----------------9,130.000
10,454.000
3,445.000
2,999.000
1,541.000
@CF
654.000
-------------8,639.000
23,369.000
22,552.000
21,896.000
11,521.000
10,889.000
10,668.000
------------------ ------------------ -----------------11,848.000
11,663.000
11,228.000
NA
3,883.000
4,354.000
NA
115.000
121.000
NA
6,984.000
7,213.000
NA
1,841.000
1,291.000
13,572.000
702.000
270.000
------------------ ------------------ -----------------37,050.000
35,994.000
34,628.000
19,058.000
17,145.000
9,371.000
8,464.000
------------------ -----------------9,687.000
8,681.000
3,690.000
3,485.000
149.000
186.000
6,443.000
5,704.000
625.000
2,977.000
206.000
240.000
------------------ -----------------29,930.000
31,727.000
15,930.000
7,781.000
-------------8,149.000
3,284.000
0.000
5,440.000
0.000
2,475.000
-------------27,987.000
435.000
273.000
526.000
NA
96.000
0.000
7,772.000
2,846.000
2,562.000
412.000
145.000
151.000
NA
2,843.000
2,894.000
0.000
2,584.000
1,620.000
------------------ ------------------ -----------------8,619.000
8,787.000
7,753.000
@CF
143.000
274.000
2,746.000
2,102.000
1,799.000
90.000
546.000
2,587.000
2,581.000
1,807.000
1,591.000
------------------ -----------------6,860.000
9,406.000
160.000
894.000
1,731.000
99.000
2,377.000
1,491.000
-------------6,752.000
8,185.000
7,858.000
4,203.000
260.000
226.000
646.000
@CF
0.000
0.000
432.000
0.000
0.000
5,577.000
7,017.000
4,792.000
------------------ ------------------ -----------------23,073.000
23,888.000
17,394.000
2,550.000
2,313.000
528.000
1,434.000
0.000
0.000
0.000
0.000
4,624.000
4,323.000
------------------ -----------------14,562.000
17,476.000
2,397.000
1,216.000
0.000
0.000
4,099.000
-------------14,464.000
@CF
(97.000)
(91.000)
(100.000)
0.000
0.000
------------------ ------------------ -----------------(100.000)
(97.000)
(91.000)
(79.000)
(69.000)
0.000
0.000
------------------ -----------------(79.000)
(69.000)
(49.000)
0.000
-------------(49.000)
30.000
30.000
30.000
269.000
351.000
450.000
27,627.000
25,944.000
27,232.000
13,849.000
14,122.000
10,387.000
------------------ ------------------ -----------------14,077.000
12,203.000
17,325.000
------------------ ------------------ -----------------13,977.000
12,106.000
17,234.000
------------------ ------------------ -----------------37,050.000
35,994.000
34,628.000
30.000
30.000
584.000
614.000
22,591.000
20,063.000
7,758.000
6,387.000
------------------ -----------------15,447.000
14,320.000
------------------ -----------------15,368.000
14,251.000
------------------ -----------------29,930.000
31,727.000
30.000
618.000
17,844.000
4,920.000
-------------13,572.000
-------------13,523.000
-------------27,987.000
25