Analysis: PEP MKC

One of the companies in the Bullpen that we are starting to warm up to is beverage and snack giant PepsiCo (PEP) . The company is a treasure trove of brands across its beverage and snacking portfolio, which PepsiCo has also been updated and leaning into healthier alternatives to meet evolving consumer preferences. And as we've commented before, people need to eat and drink no matter what the economic environment and that has led them to perform well historically during inflationary periods. It also helps that inelastic quality lends PepsiCo pricing power.

We will share that we are not in love with PepsiCo's segment reporting, which tends to rely on a bit too much in our view on acronyms. Here's the current business breakdown:

  • Frito-Lay North America (FLNA), which includes branded convenient food businesses in the United States and Canada: 25% of 2021 total revenue; 44% of 2021 total operating profit;
  • Quaker Foods North America (QFNA), which includes branded convenient food businesses, such as cereal, rice, pasta and other branded food, in the United States and Canada: 3.5% of 2021 revenue; 4.5% of 2021 operating profit;
  • PepsiCo Beverages North America (PBNA), which includes beverage businesses in the United States and Canada: 32% of 2021 revenue; 19% of 2021 operating profit;
  • Latin America (LatAm), which includes all beverage and convenient food businesses in Latin America. 10% of 2021 revenue; 11% of 2021 operating profit;
  • Europe, which includes all beverage and convenient food businesses in Europe: 16.4% of total 2021 revenue; 10% of total 2021 operating profit;
  • Africa, Middle East and South Asia (AMESA), which includes all beverage and convenient food businesses in Africa, the Middle East and South Asia: 7.6% of total 2021 revenue; 6.7% of 2021 operating profit; and
  • Asia Pacific, Australia and New Zealand and China Region (APAC), which includes all beverage and convenient food businesses in Asia Pacific, Australia and New Zealand, and China region: 5.8% of total 2021 revenue; 5.2% of 2021 operating profit.

Our goal in the above was to show the key determinants of PepsiCo's revenue and earnings are its domestic snack and beverage businesses, which in aggregate drive 60% of consolidated revenue and two-thirds of its operating profit. We would also point out that while Asia-Pacific is 6% to revenue, China is half that, which means limited exposure to that market. Given the current environment, we like the limited China exposure and we're revisiting the shares as the company has already shed its former Russian businesses, which means any adjustments have already been baked into the company's guidance. The positive of this is we can rely on the number of domestic facing consumer spending points, including the monthly retail sales report and others like it, to gauge the relative health of PepsiCo's snacking and beverage business.

Given concerns over consumer spending, we suspect we will see a reversion back to a more normalized demand pattern between dining out and eating at home, which should benefit PepsiCo's food and beverage offering.

While there are a number of ways, we could point out the company's ability to navigate good times and bad, perhaps the most telling is the early May announcement of its latest dividend increase. This latest increase not only marks PepsiCo's 50th consecutive annual dividend increase, but the 7% bump moves the annualized dividend to $4.60 per share up from the prior $4.30. The new dividend is payable on June 30 to shareholders of record on June 3. A critical point to be made here is that even during the recessionary periods depicted in the above chart, PepsiCo still increased its annual dividend and generated positive earnings per share.

Much like with McCormick & Co. (MKC) , that track record adds another way to value PEP shares above and beyond historical price-to-earnings metrics. In looking at both multi-year averages for both of those valuation tools, we can see upside to the $177 level, which equates to a divided yield of 2.6% and a P/E of 24-times applied to 2023 EPS expectations of $7.23 per share. In terms of downside, similar metrics suggest potential downside to $150-$155, which means at the current share price the upside to downside tradeoff in PEP shares is neutral. Should PEP shares retreat to or below the $160 level, the improved risk-to-reward tradeoff would lead us to call the shares up to the active portfolio.

AAP is long MKC.