To The Moon

$Pepsi(PEP)$

After a significant sell-off in December 2024, PepsiCo's stock is now trading at its 52-week low. Interestingly, this price level is not only a yearly low but also the lowest the stock has reached since October 2021, effectively placing it at a three-year low.

Earning Overview

What stands out here is PepsiCo's forward price-to-earnings (P/E) ratio, currently at 18.66. By comparison, the company's five-year average P/E ratio is around 24. This represents a 22-23% discount from its historical valuation, leading many to believe the stock may be undervalued.

Furthermore, examining the dividend metrics shows a starting dividend yield of 3.55%. Historical data from Seeking Alpha indicates that this is the highest starting yield for PepsiCo in the past decade, excluding the 2020 market crash.

This articles aims to address whether PepsiCo's recent sell-off presents a compelling buying opportunity.

Sell-Off Overview

The sell-off began around mid-October, coinciding with PepsiCo's quarterly earnings report on October 8th. The report revealed a revenue miss, and earnings results varied depending on accounting practices used. PepsiCo also revised its 2024 outlook, expecting a low single-digit organic revenue increase, down from a previously estimated 4%. This cautious guidance initially disappointed investors.

Additionally, two macroeconomic factors have influenced the stock's performance:

Regulatory Concerns: President-elect Donald Trump’s selection of Robert F. Kennedy Jr. as Secretary of Health and Human Services has sparked speculation about increased scrutiny of companies in the processed food and beverage industries, including PepsiCo. However, this remains speculative.

Interest Rate Policy: On December 18th, the Federal Reserve announced interest rate cuts as expected but also indicated fewer cuts than anticipated for 2025. This unexpected decision triggered a broad market sell-off, with consumer discretionary stocks, including PepsiCo, experiencing a 4.5% decline—their worst day in over two years.

Fundamental Analysis

When examining PepsiCo's revenue per share, it remained relatively stagnant during the first half of the past decade. However, from 2019 to the end of 2023, it grew significantly, increasing from approximately $48 per share to $66.48 per share.

A deeper dive into the metrics reveals some notable trends. For instance, PepsiCo's 5-year revenue compound annual growth rate (CAGR) stands at 7.18%. However, the 5-year net income CAGR is -6.23%, skewed by an outlier year in 2018. While earnings per share (EPS) did decline from 2018 to 2023, the longer-term trend over the past decade shows clear growth.

PepsiCo is known as a long-established Dividend King with stable cash flows, supported by a gross profit ratio that has remained steady over the past decade. The gross profit ratio was 54.2% last year, matching its 10-year average.

Dividend Metrics

Despite short-term pressures, PepsiCo’s dividend metrics remain attractive:

• Starting Yield: The 3.55% yield is among the highest in a decade.

• Dividend Growth: The company boasts a 10-year compound annual growth rate (CAGR) of 7.7% and a five-year CAGR of 7%, in line with its most recent 7.1% dividend increase in early 2024.

• Dividend History: PepsiCo is a Dividend King, having increased its dividend for over 50 consecutive years.

Free Cash Flow

However, there’s a caveat. The company’s free cash flow (FCF) payout ratio now stands at 84.3%, up from about 50% a decade ago. In 2023, PepsiCo generated $7.9 billion in FCF while paying out $6.68 billion in dividends. This trend suggests a tightening margin for reinvestment, a potential concern for long-term investors.

In conclusion, while the recent sell-off has created compelling valuation and dividend metrics, investors must weigh these against potential risks, including regulatory uncertainty and a narrowing FCF margin. Is this a buying opportunity? Let’s explore further.

Guidance

PepsiCo has outlined several strategic goals for 2025, focusing on sustainability and operational efficiency:

Packaging Sustainability: The company aims to design 100% of its packaging to be recyclable, compostable, biodegradable, or reusable by 2025. However, current projections estimate achieving 98% by that year, with 92% meeting end-of-life solution criteria. PepsiCo continues to innovate and invest to reach its 100% goal.

Net-Zero Emissions Plant: PepsiCo plans to achieve its first net-zero emissions plant by 2025 at its beverage facility in Álava, Basque Country, Spain. This initiative involves complete electrification of the plant, eliminating nearly 2,000 tonnes of CO2 emissions annually.

Sustainable Farming: The company intends to expand its Sustainable Farming Initiative to approximately 7 million acres by 2025, covering crops that collectively represent about 75% of its agricultural-based spend.

Technical Analysis

Technical analysis indicates that PepsiCo is in a declining trend channel over the medium to long term, suggesting that investors have been selling shares over time. The stock has support at $140.43 and resistance at $161.59.

Analyst forecasts for PepsiCo's stock price by the end of 2025 vary. Some predict a potential increase to approximately $161.59, representing an 11% rise from the current price.

Risks and Challenges

Regulatory Concerns: Speculation about increased scrutiny of processed food and beverage companies under the new administration may weigh on investor sentiment.

Interest Rates: The Federal Reserve's decision to scale back rate cuts for 2025 has dampened the market, particularly for consumer staples, as higher rates impact valuations.

Valuation

Let’s explore PepsiCo's valuation, starting with its beta, which is currently 0.54. A beta of 0.54 indicates lower volatility, as PepsiCo's stock is expected to move about half as much as the broader market. This low beta, combined with stable cash flows, makes PepsiCo attractive to investors seeking low-risk investments with consistent returns.

Discounted Cash Flow (DCF) Analysis

Assuming a 5% free cash flow growth rate, PepsiCo's DCF valuation estimates a fair price of $95.62 per share, about 19.54% below its trading price.

Historical Multiple Valuation

PepsiCo's average P/E ratio over the past decade is approximately 26, compared to its current trailing 12-month P/E ratio of 22.4, reflecting a ~15% discount. For mature companies like PepsiCo, this approach is particularly relevant due to their predictable cash flows, aligning with the mean reversion theory that valuations eventually return to historical averages.

Dividend Discount Model (DDM)

Using a 4.75% dividend growth rate, the DDM calculation gives an intrinsic value of $171.79 per share.

Combining these valuation methods, the average intrinsic value for PepsiCo is $156 per share. With a 10% margin of safety, the acceptable buy price would be around $140.41 per share.

Market sentiment

Comparing PepsiCo to Coca-Cola

PepsiCo is frequently compared to Coca-Cola, but there are key differences. For example, in 2023, 41% of PepsiCo's net revenue came from beverages, while 59% came from food. This is a stark contrast to Coca-Cola's beverage-centric model.

Low Volatility With a beta of 0.54, PepsiCo offers a less volatile investment, appealing to risk-averse investors seeking steady returns amidst market uncertainty.

Slowing GrowthWhile revenue has grown, net income has struggled due to increasing costs and other headwinds. A 5-year net income CAGR of -6.23% raises concerns about the company's ability to sustain long-term profitability.

Conclusion

PepsiCo typically trades at a premium, and opportunities to buy it below intrinsic value are rare. Whether it's a good buy depends on your investment goals. If you prioritize low volatility, predictable earnings, and stable dividend income, PepsiCo is an attractive option, especially given its current valuation. However, if you're focused on higher growth in earnings, free cash flow, and dividends, there may be better opportunities elsewhere in the market.

While PepsiCo might revert to its mean valuation and even outperform the market in the short term, investors with long-term growth objectives might seek other options. Let me know your thoughts on PepsiCo in the comments below!

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