The stock of soft drinks and snacks giant PepsiCo over the last five years has done exactly nothing. Dividends were the only form of returns, but this will hardly make investors high-five this market-lagging performance. With a just raised-again dividend, a yield on the high-end of the historical range, a comparatively low PE ratio of 16x and an uncertain economic environment, this consumer staple company might qualify for a defensive portfolio.
Summary and key takeaways from today’s Weekly
– Over the last 50 years, Pepsi’s stock has beaten its arch-rival Coca-Cola by a wide margin, but it has lost much ground over the last one and a half years.
– Especially among dividend investors, Pepsi is one of the darlings, highly celebrated for its consistent payouts.
– Despite optically looking like an almost risk-free buying opportunity, under the hood it does not look so pretty.
I am not telling you a secret that in times of a weak economy, companies with defensive business models are likely the better choice – at least compared to much more cyclical alternatives.
My personal preference goes more towards mixing in certain commodities and special situations, but I know there are many investors interested in dividend stocks with less to non-cyclical operations.
In the past, it was almost a no-brainer to buy tobacco, household, alcohol as well as non-alcohol beverage and food companies to switch from offense to defense. However, as I wrote on several occasions, this common wisdom has lost some of its practical applicability, especially in the case of alcohol stocks (see here, here and here).
Also, I had already looked from a bird’s eye view at foods stocks (see here). Unfortunately, with a similar result – hardly attractive, as the former growth trends have come to a standstill while valuations remain prohibitively expensive for what an investor receives by buying these stocks.
PepsiCo (ISIN: US7134481081, Ticker: PEP) is another such darling, especially among income investors. Its stock over the last five years has delivered a stock price return of exactly zero percent. If it stays around 130 USD, the stock will not have moved over the last six years even when we reach June. Is this now a great buying opportunity at a PE ratio of 16x and a dividend yielding 4.3%?
Let’s find out!
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Where has the carbonic acid gone?
While researching this case, I stumbled upon a very interesting chart I could not withhold. The stock of Pepsi has massively outperformed its biggest rival Coca-Cola (ISIN: US1912161007, Ticker: KO) over the last half century.
Not just by a little, but by a wide margin.
Please raise your hand if you knew this – I didn’t.
This comparison is a bit flawed and short-sighted, though, as Pepsi in between had spun-off Yum! Brands (ISIN: US9884981013, Ticker: YUM) which today has a market cap of 41 bn. USD on its own.
PepsiCo acquired Pizza Hut (1977, 300 mn. USD), Taco Bell (1978, 148.5 mn. USD) and KFC (1986, 850M mn. USD). It spun off these chains as Tricon Global Restaurants (later renamed to Yum! Brands) in 1997 for a 4.5 bn. USD distribution.
Looking at the chart below, it likely would have been better to keep these brands…
The other thing is, Coca-Cola until today is a focussed beverages company (though with more than 500 brands), while Pepsi has been a mix of soft drinks and snacks. Frito-Lay is likely the best known snacks brand it owns.
For a reason.
Pepsi’s pivot to snacks began with the 1965 merger with Frito-Lay, which established its dominance in the snack market. The Quaker Oats acquisition (2001, 13.4 bn. USD) added significant breakfast and snack portfolios, including Gatorade. Bare Snacks (2018, ~200 mn. USD) and Pioneer Foods (2020, 1.7 bn. USD) further expanded its global snack presence.
Frito-Lay alone holds ~40% of the U.S. snack market, with brands like Lay’s and Doritos leading globally. According to Statista (see here), the US snacks market which is the biggest in the world had sales of more than 50 bn. USD in 2024. The snacks division of Pepsi achieved 24.7 bn. USD in sales last year.
Looking now into the latest quarterly report, it might surprise one or the other that Pepsi is generating most of its sales and even more of its operating profit from its snacks business – making the name Pepsi from the soft drink of the same name a bit misleading for the company as a whole.
Crunching the numbers and adding them up back-the-envelope, we can say that Pepsi generates a bit more than 50% of its sales from snacks (the EMEA segment has both, snacks and beverages) which for itself is not so shocking.
Turning to operating profits, the share rises to about three-quarters.
Even more surprising for me was the weak profitability of the North American drinks segment. But this is quickly explained as Pepsi is partly bottling its drinks itself and partly via independent bottlers while Coca-Cola has outsourced the bottling for a higher-margin and more asset-light business.
On the first chart above, we’ve seen that Pepsi had a phenomenal run and an astronomical rise, but has lost heavily on the last meters so to speak.
As teased in the intro, PEP is now again where it was five years ago.
Compared with Coca-Cola, it gets really painful, especially since late-2023 / early-2024. Coca-Cola has outperformed Pepsi by 60% over the last one and a half years.
60%!
So what has happened?
The answer is quick and simple: growth has turned to zero for Pepsi, while its arch-rival continued to post modestly growing figures.
This does not apply just to sales, but also to below the top-line.
| figures each from fiscal year 2023 until present | PepsiCo | Coca-Cola |
| sales | 91.4 bn. –> 91.5 bn. | 45.7 bn. –> 46.9 bn. |
| operating earnings | 14.0 bn. –> 14.3 bn. | 13.2 bn. –> 14.2 bn. |
source: TIKR
We can also see that Coca-Cola generates practically the same among of operating earnings at only half the sales – margins a much higher.
Looking again into the latest quarterly report of Pepsi, we can see that especially the important food segment has stepped on the brakes with both feet.
If this was shocking, then better skip the operating earnings figures.
Doesn’t look pretty to me.
On the latest earnings call, management cited three reason for why it lowered its outlook, namely tariffs, macro and consumer uncertainty in general, but also Frito-Lay weakness in North America. Regarding the latter, a recovery is expected to take time. Volumes have taken a hit by 4% as consumers are turning to value brands, i.e. cheaper alternatives.
Now in my words: forget this pricing power and brand premium garbage as a competitive advantage. This works only in a strong, flourishing economy.
Ouch… This is not what the market wanted to hear.
Obviously, the question now is whether this has been priced accordingly into the stock. Has Pepsi gotten discounted enough to consider it worthwhile?
As of writing, Pepsi’s stock trades for an almost unheard of 16x price to earnings ratio. Over the last almost 20 years, Pepsi has traded the the biggest part of the period for more than 20x earnings. For brief moments even above 30x and in 2023 going entirely nuts by overshooting to above 40x.
As my longer-time readers know, the PE ratio is only half the truth, as it leaves of the debt component. Even though Pepsi has a defensive business model, it carries around a not small almost 40 bn. USD net debt baggage with it.
This is a cool more than 5x free cash flow.
Speaking of free cash flow, it is lower than it was a decade ago.
Looking at sales which have increased from 63. bn. USD to more than 90 bn. USD over the same period, this is a pure disappointment.
So now, adding the market cap of 180 bn. USD and the debt load of 40 bn. USD, the total enterprise value of 220 bn. USD still looks quite high against a free cash flow of only 7.2 bn. USD.
A cool 30x multiple – still, for a not growing business.
As many of my readers know, I am not so convinced of the common narrative of so-called enduring brands and moats through strong brands. Add to this that the forever growth story clearly has seen some cracks, I cannot justify a 30x multiple.
It should trade for 15x EV / FCF which would be a downside of 42% for the stock.
Or a price of 75 USD apiece. Hard to believe, but that would not be unreasonable.
Before I close, I wanted to look at shareholder returns, as they are often cited as the reason to own stocks like Pepsi. Not to mention that many inexperienced investors portrait these companies as shareholder friendly and generous distributors.
Is this really the case?
We have seen the development of free cash flow which at best was lackluster.
Below is now free cash flow in green against dividends in black and buybacks in blue.
With a bit of imagination and a sharp eye, we can see that free cash flow didn’t always cover the payouts to shareholders, partly explaining the higher debt load over time.
It gets even worse. Pepsi is now paying out the entire free cash flow in dividends.
Since 2016, Pepsi’s total dividend increased from 4.2 bn. USD to now more than 7 bn. USD. To maintain the appearance, it even just a few days ago raised its dividend again by 5% (see here).
That does not make much sense, respectively is another red flag for me.
Although the 4.3% yields now looks juicy compared to what one could secure in the past, with current trends this is not sustainable. Rising debt and already paying out more than is generated in free cash flow while the market environment is unfavorable.
Decide for yourself.
While the dividend is what is – not a buying argument for me – the buybacks deserve a closer look. Pepsi has spent measured by eye around 22–23 bn. USD on repurchases over the last ten years. This supporting force is likely to break away now.
One can decide for oneself, whether Pepsi’s stock is the real big deal.
I for myself clearly remain on the sidelines as the stock lacks upside despite its correction and worse, has realistic downside if the company does not turn the corner operationally.
Conclusion
Over the last 50 years, Pepsi’s stock has beaten its arch-rival Coca-Cola by a wide margin, but it has lost much ground over the last one and a half years.
Especially among dividend investors, Pepsi is one of the darlings, highly celebrated for its consistent payouts.
Despite optically looking like an almost risk-free buying opportunity, under the hood it does not look so pretty.
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