Pouring Over Pepsi (PEP)

PepsiCo (PEP) has 18 global mega-brands, each with annual sales of more than $1 billion, and they include Pepsi Cola, Gatorade, Mountain Dew, Fritos, Lay’s, Doritos, Tostitos, and Quaker.  Pepsi is a global beverage, snack and food company and makes a wide range of snacks, carbonated and non-carbonated beverages, and foods that it sells in some 200 countries.

Company Background

Sales in PEP’s North American beverage segment fell 7% in the second quarter of this year while Coke’s sales fell only 1% according to Morningstar.  However, Pepsi’s snack food segment showed solid growth.  Its North American snack business is PEP’s most profitable sector, generating 33% of its total sales and 44% of its profits.  Through its Frito-Lay division, PepsiCo is the world’s largest snack food company, controlling almost 40% of the U.S. salty snack market and around 30% of the non-U.S. market.

PEP’s latest 10Q quarterly report shows that Frito-Lay is the largest of its six segments accounting for 30% of Net Revenues for the last 12 weeks and 33% for the last 24 weeks.  Sales of Pepsi Cola and other beverages by the Pepsi Americas segment amounted to 25% in both periods.  Bottle Case Sales, a common measure PEP uses for all of its soft drinks, declined 6% “reflecting continued softness in the North American liquid refreshment category.” (7-22-09, page 34) Worse, non-carbonated beverage volume in North America dropped 14%, primarily due to double digit declines in Gatorade sports drinks and Aquafina water.

And, PEP’s sales have declined for four consecutive quarters.

In August, PEP announced it had reached a deal to buy the outstanding shares of its two main bottlers for $7.8 billion, ending a months-long disagreement over the price.  Before the deal was final, Value Line thought the purchase would contribute to long-term growth of sales and EPS.  However, with declining sales of carbonated and non-carbonated soft drinks, I don’t understand what Pepsi hopes to concretely accomplish.

Below, I compare and then discuss AnnC’s SSG, which I got from BI’s First Cut page, with mine and with Take Stock.

PepsiCo                    (PEP)	AnnC, from BI’s First Call	Armin	Take Stock
Date	7-13-09	7-17-09	7-16-09
Data	S&P	Same	Hemscott
Price	$55.52	$56.66	$57.28
52 week High & Low Price	$72.25 & $43.78	Same &             Same	Not Included
Last Quarter of Reported Data	Q1 ending           3-31-09	Same	Same
Software Used	TK 5	Same	TS Online
Project Growth From End of	Last FY	Last Q	Last FY
Sales Growth	6.00%	8.00%	8.50%
EPS Growth	7.00%	8.00%	-5.1%
High PE	20.0	21.0	22.5
High EPS	$4.85	$5.13	$2.47
High Price	$97.00	$107.20	$55.49
Value Line Estimated High Price = $90-110 as of 5-1-09 and 7-31-09
Low PE	12.0	14.4                   (from 2008, lowest in last 10 years)	17.3
Low EPS	$3.49 (TTM)	Same	$3.17
Low Price	$41.90          (Low PE x         Low EPS)	$43.80             (Recent Severe Low Price)	$57.28               (same as Current Price)
Upside/Down	3.00	4.0	Impossible to Calculate
Total Return	13.8%	15.6%	2.2%
Final Result	SSG HOLD	SSG BUY	DON’T BUY
SSG Buy Under	$53.00	$60.85	$31.39
RV/PRV                 (no outs)	77.6/72.5	79.0/73/3	Not Included
Quality	N/A	A+	2.2 (Unacceptable)
PTPM – 5 yr ave	19.3%               Trend down	Same              Same	18.9%                      Trend N/A
ROE – 5 yr ave       with End Equity	33.4%               Trend down	Same                Same	Not Included
ROE – 5 yr ave      with Start Equity	N/A	33.8%               Trend down	33.9%                  Trend N/A
Debt to Equity –  5 yr ave	N/A	27.8%                Trend up	Not Included

DISCUSSION

1. EPS Estimates:

(A) AnnC’s SSG

** Ann used the BI/NAIC Preferred Procedure to estimate 7.00% EPS growth. Her PP was based on the following five estimates: 6.00% Sales growth [less] 18.0% Pre-Tax Profit Margin (overriding the 19.3% default) [less] 26.7% Tax (default) [less] -0- Preferred Dividends (overriding the $2.0 per share default [divided by] 1556 M Shares Outstanding (default) [equals] 7.2% EPS. Ann used 7.0% EPS.

** Compared to Ann’s 6.00% expected Sales growth, Zacks.com estimated 10.17% while Morningstar Premium estimated 4.00% internal growth.  However, Mstar recognized that PEP’s nearly 10.00% historical Sales growth in the last 5 years included several acquisitions and also the advantageous effects of a weak dollar.

** Unlike Ann, I no longer use the PP and think it involves too many estimates and too much guesswork. Moreover, if you start with a low estimate of Sales growth, you usually wind up with a very low EPS estimate. See: Pondering the Preferred Procedure, http://arminfields.wordpress.com/2009/03/28/pondering-the- preferred-procedure/

(B) Armin’s SSG

** When I did my SSG, the six analysts I always check were estimating long term EPS at an average of 9.775% with Zacks.com high at 11.53% and Value Line low at 8.00%. First Call via YahooFinance was 9.47%, Reuters.com was 9.65%, and S&P and FactSet CallStreet via CNN Money were both 10.00%.

** Three analysts contributed to the consensus at Reuters and ranged from 10.0% to 8.9%. The three analysts at FactSet ranged from 11.0% to 9.0%.

** I used 8.00% EPS based on Value Line’s estimate which was the lowest of all the estimates.  To know which is the lowest, we must check all six.

** PEP’s historical EPS has been steadily declining for the last 5 years from 11.0% in 2004 down to 2.7% in 2008.

(C) Take Stock

** TS estimated -5.10% EPS (that’s a negative 5.10%) which was a whopping 14.80% less than the average of the six analysts and 13.10% less than VL, the lowest of the six estimates.  I consider that unreasonably conservative and, once again, we need to check all six analysts to make that judgment.

 2. Forecast High Prices:

** Ann’s Forecast High Price was $97.00 which was close to, but not below, the low end of VL’s $90-110 estimate.

** I got $107.70 which was close to, but not above, the high end of VL’s estimate.

** Both forecasts seem reasonable to me as my rule of thumb is to never substantially exceed or fall below VL’s estimate, at least not without a good reason. See:     Determining What’s Reasonable and What’s Not: An Update, http://arminfields.wordpress.com/2009/07/15/determinung-whatsreasonable-and-whats-not-an-update/

** Take Stock’s Forecast High Price was $55.49 which was a huge 38% below the low end of VL’s $90-110 estimate and which, once again, seems unreasonable and irrational by comparison since PEP was then currently selling for $57.28.

3. Pre-Tax Profit Margin and Return on Equity

(A) PTPM

** With S&P data, which Ann and I both used, PEP’s 5-year average PTPM was 19.3% and trending down.  Down trends are usually a red flag indicating poor performance. However, S&P places PepsiCo in the Soft Drinks Industry whose 5-year average PTPM was 11.6%, substantially worse than PEP.

** With Hemscott data, which Take Stock used, PEP’s average PTPM was 18.9% while its industry average, this time in the Processed and Packaged Goods Industry, was 8.1% and again substantially worse than PEP which ranked third of 61 companies (as of May 6, 2009).

(B) ROE

** With S&P data, PEP’s average ROE was 33.4%, trending up, and its industry average of 20.9% was substantially worse.

** With Hemscott data, PEP’s average ROE was 33.3% and again its industry average of 21.0% was substantially worse. PepsiCo ranked 7 out of 61 companies.

 4. Final Results :

 ** Ann got a SSG Hold with a 3.0 Upside/Downside ratio and a 13.8% Total Return which did not satisfy the minimum 15.0% TR criteria.

** I got a SSG Buy with a 4.0 U/D and a 15.6% TR.

 ** Take Stock does not use the Buy, Hold or Sell criteria nor the U/D concept and it seems likely that TS would say Dump/Don’t Buy PEP.

** S&P rated PepsiCo’s quality as A+ while Take Stock rated PEP a 2.2, unacceptable.

 5. Final Thoughts:

** Ann projected future growth from the last FY while I used the last Quarter.  If she had projected from the last Q, her U/D would have been 3.1 (instead of 3.0) and her Total Return would have been 14.8% (instead of 13.8%). That is an almost SSG Buy and, as the FY progresses with one or two more reported quarters, is likely to be a solid SSG Buy.

** Regardless of what my SSG shows, I’m not impressed with PepsiCo.

- Armin

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