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Stocks tied to vice can be profitable. Just ask people who have owned stock in tobacco companies. Tobacco is an addictive product, and producers like Altria (MO) have been able to pay growing dividends for decades. Not all companies that offer addictive products are “sin stocks” that produce tobacco or alcoholic beverages.
PepsiCo (NASDAQ:PEP) is best known for its caffeinated beverages like Pepsi Cola and Mountain Dew. I appreciate the citrus flavor of Mountain Dew, and there are millions of others like me who pay money to PepsiCo on nearly every visit to grocery or convenience stores. Many successful investors have grown their wealth by investing in products they understand. Although they’re somewhat less popular today as people concern themselves with health, sodas (or pops, depending upon your geographic location) are still cash cows. Therefore, PepsiCo could be a great option for those who want steady dividend income. The only concern at this point might be a high valuation.
While Pepsi Cola is the flagship product, there are other beverage and snack offerings that bring in cash for PepsiCo. Doritos and Lay’s potato chips are popular snack options. Additionally, Quaker Oats is a common choice for those who like to eat breakfast. Pepsi also markets Starbucks drinks (another addictive caffeinated beverage) and Gatorade. Each of these products has a diverse market, and they contribute to the massive revenue stream Pepsi brings in every year.
Financials
The most recent annual report showed that PEP has more than kept up with the recent run-up in prices. Net revenue for 2021 was a whopping $79.474 billion, and this was up from $70.372 billion the previous year. Overall, revenue was up 13% on a year-over-year basis. Frequently, companies will have extra expenses that can cut into their profits even when revenues go up. This was not the case with Pepsi over the past year. EPS came in at $6.26 for 2021, which was also an increase of 13%. Free cash flow increased by 11%. Analyzing net income on a trailing twelve-month basis shows a profit of $9.236 billion, which is around 50% higher than what it was 10 years ago, although net income has varied over that time, at one time (2017) dropping below $5 billion.
The revenue stream is well diversified, both in terms of product offerings and geography. “Convenient Foods” made up 55% of revenue, outstripping the beverage brands, which contributed only 45% of net revenue. Those who like international diversification should also appreciate PepsiCo. The company’s international exposure sees Pepsi selling its wares around the world. Pepsi sees 44% of its revenue coming from outside the US.
With that said, however, it’s important to see that North America is the most profitable sector, with about two-thirds of operating profit coming from this region. About three-fourths of revenue and income originate in North America or Europe. Indeed, when I lived in Lithuania for a few months in 2018, Pepsi was present there, although it took up a small fraction of the shelf space occupied by its main competitor, Coca-Cola (KO). I was able to pick up some tasty Lay’s potato chips at local grocery stores.
Pepsi’s position as a consumer staple company makes it less exposed to recession than some of the other major companies in the US. This is evidenced by the next area of analysis: the dividend.
Dividends
Dividend-focused investors should like PEP for its dividend history, if for nothing else. The company has been paying a quarterly dividend since LBJ was president. Investors have received a cash dividend from PepsiCo every quarter since 1965. Additionally, the company is coming up on five decades of annual dividend growth.
It’s frequently said that the safest dividend is the one that’s just been raised. PepsiCo raised its dividend again in February 2022, and the most recent raise was 7% to $4.60 a year/$1.15 per quarter. This is largely in line with the 7.39% average increase the company has offered over the past five years. The current yield is 2.63%, which is well above the current yield on the S&P 500 (1.58% as of August 26, 2022). Additionally, should Pepsi maintain an annual dividend increase of 7%, the dividend payout will double in about 10 years, and the yield on cost would then be nearly 5.3%. There are options that pay a higher yield now, but frequently, dividend growth in high-yield stocks is not likely to be as robust over time.
The current dividend payout ratio is 67.62%, which means that PEP could continue growing the dividend in the future provided revenue and income continue to increase, even marginally, over time.
The company also provided another avenue for providing returns to shareholders in the near term. In February 2022, the company announced its intention to buy back up to $10 billion worth of shares in the next four years. In 2022 alone, PepsiCo intends to buy back $1.5 billion of stock. This might be bad timing, as a discussion of valuation should reveal.
Companies frequently purchase their own stock when prices are high, which means that the dollars going to repurchasing shares buys fewer shares. Pepsi recently hit an all-time high north of $180/share. Waiting for a dip to buy back shares would provide a better shareholder return, although even buying at a high can still benefit shareholders because fewer shares will be on the market. This helps income in a couple of ways. First, with fewer shares on the market, EPS should be higher if all other things remain equal. Second, there will be fewer shares receiving dividends, which cuts that expense. Both factors could be positive for share price.
Concluding Thoughts
PepsiCo is a great American company. This corporation has a strong stable of food and beverage brands people love to ingest. The company provides instant diversification through its international operations. Revenue and income have grown over the past decade, and the past year had some even higher growth in that regard. PEP is a strong play for dividend investors, with 49 consecutive years of dividend growth and a yield that beats the S&P 500 by more than a full percentage point.
However, those who are looking at Pepsi as a value play might want to consider its relatively high P/E ratio. The company is selling at 26.36 times earnings, which is higher than that of the 20.50 of the S&P 500 as a whole as of August 26, 2022 (according to multpl.com). The company’s stock has just retreated off of all-time highs, and there might be little room for PepsiCo to run in the short term. Additionally, stock prices that are at or near an all-time high will mean buyback funds will purchase fewer shares off the market. However, those looking for long-term dividend growth with a decent, but not great, yield will likely find Pepsi a great long-term buy.
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