PepsiCo Inc. - Zacks Investment Research

[Pages:11]February 12, 2015

PepsiCo Inc.

(PEP-NYSE)

Current Recommendation

Prior Recommendation Date of Last Change

NEUTRAL

Underperform 02/05/2004

Current Price (02/11/15) Target Price

$100.40 $105.00

SUMMARY

Pepsi has a superb 2014, beating the Zacks Consensus Estimate for both earnings and revenues in all the quarters of the year. Fourth quarter earnings of $1.12 per share increased 6% year over year on strong organic revenues, lower taxes, better execution and productivity gains. Organic revenues increased 5% driven by increased product pricing and better volumes. Overall, we are encouraged by the company s strong brand portfolio, product and geographic diversity, improved productivity, increased brand building investment and market execution, efforts to innovate and solid cash flow generation. Also, the company s plan to substantially increase shareholders return and extend productivity initiatives are encouraging. However, challenging consumer spending environment, currency headwinds, and continued sluggish CSD volumes keeps us on the sidelines.

SUMMARY DATA

52-Week High 52-Week Low One-Year Return (%) Beta Average Daily Volume (sh)

Shares Outstanding (mil) Market Capitalization ($mil) Short Interest Ratio (days) Institutional Ownership (%) Insider Ownership (%)

$100.40 $77.10 26.18 0.42

5,296,764

1,497 $150,298

2.14 68 0

Annual Cash Dividend Dividend Yield (%)

5-Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%)

$2.62 2.61

8.0 3.3 7.2

P/E using TTM EPS

P/E using 2015 Estimate P/E using 2016 Estimate

Zacks Rank *: Short Term 1 3 months outlook

* Definition / Disclosure on last page

21.7 20.9 19.3

3 - Hold

? 2015 Zacks Investment Research, All Rights reserved.

Risk Level *

Type of Stock Industry Zacks Industry Rank *

Low

Large-Growth Beverages-Soft

189 out of 267

ZACKS CONSENSUS ESTIMATES

Revenue Estimates

(In millions of $)

Q1

Q2

(Mar)

(Jun)

2013 2014 2015 2016

12,581 A 12,623 A 12,348 E

16,807 A 16,894 A 16,615 E

Q3 (Sep)

16,909 A 17,218 A 16,978 E

Q4 (Dec)

20,118 A 19,948 A 20,478 E

Year (Dec)

66,415 A 66,683 A 66,419 E 68,755 E

Earnings Per Share Estimates

(EPS is operating earnings before non-recurring items, but including employee stock options expenses)

Q1

Q2

Q3

Q4

Year

(Mar)

(Jun)

(Sep)

(Dec)

(Dec)

2013 2014 2015 2016

$0.77 A $0.83 A $0.83 E

$1.31 A $1.32 A $1.37 E

$1.24 A $1.36 A $1.38 E

$1.05 A $1.12 A $1.22 E

$4.37 A $4.63 A $4.80 E $5.20 E

Projected EPS Growth - Next 5 Years %

7



10 S. Riverside Plaza, Chicago IL 60606

RECENT NEWS

Pepsi Ends 2014 on a Strong Note: Tops Fourth Quarter Earnings & Sales Feb 11, 2015

Pepsi ended 2014 on a superb note beating the Zacks Consensus Estimate for both earnings and revenues in all the quarters of the year.

Moreover, the company hiked its annual dividend by 7.3% and stated that it would buy back shares worth $12 billion in 2015.

Earnings Beat

Pepsi s fourth-quarter 2014 core earnings per share of $1.12 comfortably beat the Zacks Consensus Estimate of $1.08 by 3.7%. Earnings increased 6% year over year even as currency headwinds eroded sales.

Currency hurt earnings by 7%, much higher than 1% in the previous quarter, as a strong dollar eroded the value of Pepsi s overseas sales. In constant currency terms, adjusted earnings grew 14%.

Despite difficult global macroeconomic environment and significant currency headwinds, increased product pricing, better volumes, lower taxes, better execution and productivity gains boosted profits.

Core earnings exclude the impact of restructuring and impairment charges, remeasurement of certain net monetary assets of Venezuelan entities, pension lump sum settlement charge and mark-to-market losses on commodity hedges. Including these factors, reported earnings per share were 87 cents, down 23% year over year.

Strong Organic Revenues

Total sales in the quarter declined 1% year over year to $19.95 billion largely due to currency headwinds. Foreign exchange hurt revenue growth by 6%.

Excluding foreign exchange impact, revenues increased 5% on an organic basis as both price/mix and volumes improved. Revenues also marginally beat the Zacks Consensus Estimate of $19.78 billion.

Strong global snacks, improved beverage volumes in Europe and Americas and better organic sales in developing/emerging markets led to the impressive top-line results.

Organic revenues grew 10% in developing/emerging markets. In the Americas, organic revenues grew 3.5% in the Frito-Lay snacks segment helped by higher volumes and pricing. Core revenues grew 3% in the beverage business boosted by price hikes.

Pepsi witnessed an effective net pricing gain of 3.5%, higher than 3% in the past quarter. Volumes grew 1.5%, better than flat growth in the last quarter, due to improved snacks business.

Organic snacks and beverage volumes grew 2% and 1%, respectively.

Organic volumes increased 2% in the Frito-Lay segment, while improving in the other American snacks businesses. Organic volumes declined 2% in Latin America Foods better than 2.5% decline in the

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previous quarter and remained flat in Quaker Foods much better than 3% decline in the previous quarter. Organic snacks volumes grew 3% in Europe and 8% in developing and emerging markets.

With regard to beverages, Pepsi s American and European beverage volumes improved, while developing/emerging market volumes softened from the last quarter.

Organic beverage volumes increased 3% in Europe and 1.5% in developing/emerging countries.

In the Americas, beverage volumes grew 1%, better than flat growth in the last quarter. Rival, The CocaCola Company (KO), which reported just a day back, also witnessed an improvement in American beverage volumes in the fourth quarter. While Pepsi s non-carbonated beverages volume grew 4%, carbonated soft drinks (CSD) once again declined due to category headwinds.

Margins Discussion

Core gross margins improved 70 basis points (bps) helped by strong pricing, effective revenue management strategies and productivity gains.

Core constant currency operating profit improved 7% to $2.54 billion. Core operating margins grew 17 bps as gross margin gains offset higher marketing costs.

Core effective tax rate was 25.5%, lower than 28.2% a year ago.

Tops 2014 Earnings and Revenues

In fiscal 2014, revenues were flat at $66.68 billion. However, revenues marginally beat the Zacks Consensus Estimate of $66.54 billion. Organic revenues increased 4% in the year, in line with management expectation of its growing in a mid single-digit range.

Adjusted earnings were $4.63 per share which beat the Zacks Consensus Estimate of $4.59 by 1% and increased 6% year over year. Core constant currency earnings per share increased 9% in line with management expectations.

Dividend Increase; New Share Buyback Program

Pepsi announced 7.3% increase in annual dividend from $2.62 per share to $2.81 per share. Moreover, the company announced a new $12 billion share buyback program.

2015 Outlook in Line with Long-Term Targets

Pepsi expects core constant currency earnings per share to increase 7% in 2015. The target is in line with management s long-term goal of high single-digit core constant currency earnings growth.

Excluding headwinds from currency and structural changes, organic revenues are expected to grow in the mid single-digit range, also in line with the long-term targets.

Currency is expected to hurt both earnings per share and revenues by 7% in 2015.

Commodity inflation is expected in the low single-digit range. Productivity savings expected to be $1 billion would be used to offset headwinds from cost inflation and thereafter reinvested in the business.

Also, management plans to return $8.5 $9.0 billion to shareholders through significant hikes in dividends and share repurchases.

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VALUATION

PepsiCo s current trailing 12-month earnings multiple is 21.7x, representing a discount of 16.5% to the industry average of 26.0x. Over the last five years, PepsiCo s shares have traded in the range of 14.3x to 22.0x trailing 12-month earnings. Based on 2015 earnings estimate of $4.80, the stock is trading at 20.9x a 23.2% discount to the industry average of 27.2x.

At the end of the fourth quarter of 2014, the P/B multiple of the stock was approximately 8.5x, representing a premium of 70% to the industry average of 5.0x. On a ROE basis, the stock carries a trailing 12-month ROE of 29.6%, which is better than a negative return from the industry.

Our target price of $105.00 is based on approximately 21.9x of our 2015 earnings estimate. On a P/B basis, the price target is based on a P/B multiple of approximately 9.1x.

Key Indicators

PepsiCo Inc. (PEP)

P/E F1

20.9

P/E F2

19.3

Est. 5-Yr EPS Gr%

7.0

P/CF (TTM)

15.7

P/E (TTM)

21.7

P/E 5-Yr

High (TTM)

22.0

P/E 5-Yr Low (TTM)

14.3

Industry Average S&P 500

27.2 28.2 16.5 15.4

12.1

14.6

26.0

36.7

11.3

10.7

15.1

19.0

19.4

12.0

Coca-Cola Amatil Limited (CCLAY)

21.5

10.0 13.0

The Coca-Cola Co (KO)

21.0 19.8

6.3

16.8

20.7

21.7

15.0

Fomento Econ-ADR (FMX)

21.4 18.5

13.5

9.8

24.8

28.6

14.0

TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow

PepsiCo Inc. (PEP)

P/B Last Qtr.

8.5

P/B 5-Yr High

6.4

P/B 5-Yr Low

4.1

ROE (TTM)

29.6

D/E Last Qtr.

1.0

Div Yield Last Qtr.

2.8

EV/EBITDA (TTM)

12.6

Industry Average

5.0

5.0

5.0

-25.3

0.7

1.2

-0.8

S&P 500

5.3

9.8

3.2

25.5

2.1

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Earnings Surprise and Estimate Revision History

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DISCLOSURES & DEFINITIONS

The analysts contributing to this report do not hold any shares of PEP. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1121 companies covered: Outperform - 15.3%, Neutral - 76.8%, Underperform 7.2%. Data is as of midnight on the business day immediately prior to this publication.

Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.

NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET.

OVERVIEW

Headquartered in Purchase, NY, PepsiCo, Inc. is the leading global food and beverage company marketing hundreds of brands in more than 200 countries. Its principal businesses include: Frito-Lay snacks, Pepsi-Cola beverages, Gatorade sports drinks, Tropicana juices and Quaker foods.

The company is organized into six reportable segments that include

Frito-Lay North America (FLNA) (21% of 2013 sales) produces and sells snack foods in the U.S., including Lay s potato chips, Doritos tortilla chips, Tostitos tortilla chips, branded dips, Cheetos cheese-flavored snacks, Ruffles potato chips and Fritos corn chips, among others.

Quaker Foods North America (QFNA) (4%) manufactures and sells cereals, rice, pasta, dairy and other branded products and includes some popular names like Quaker oatmeal, Aunt Jemima mixes and syrups, Quaker grits, Cap'n Crunch cereal, Life cereal, among others.

Latin America Foods (LAF) (12%) manufactures markets and sells a number of snack brands, including Marias Gamesa, Doritos, Cheetos, Ruffles, Sabritas as well as many Quaker-brand cereals and snacks in Latin America.

PepsiCo Americas Beverages (PAB) (32%): The segment includes all North American and Latin American beverage businesses. The segment manufactures, markets and sells beverage concentrates, fountain syrups and many carbonated beverages (carbonated soft drinks or CSD) and non-carbonated beverages under Pepsi, Mountain Dew, Diet Pepsi, Diet Mountain Dew, 7UP, Gatorade, Tropicana, Sierra Mist, Aquafina and Mirinda brands. The segment also sells

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ready-to-drink tea and coffee products through joint ventures with Unilever and Starbucks. It also sells brands like Crush and Dr Pepper under a license agreement with Dr Pepper Snapple Group and certain juice brands licensed from Dole Food Company and Ocean Spray Cranberries.

PepsiCo Europe (21%): The segment includes all beverage, food and snack businesses in Europe, including South Africa (SA). Snack brands include Lay's, Walkers, Doritos, Ruffles, Cheetos as well as many Quaker-brand cereals and snacks while beverage brands include Pepsi, Pepsi Max, 7UP, Diet Pepsi and Tropicana. The division also sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name) and some leading dairy products including Domik v Derevne, Chudo and Agusha.

PepsiCo Asia, Middle East and Africa (AMEA) (11%): The segment includes all beverage, food and snack businesses in AMEA excluding SA. Snack brands include Lay s, Doritos, Cheetos, Kurkure, Smith s and Chispy as well as many Quaker-brand cereals and snacks. Beverage brands include Pepsi, Mirinda, 7UP, Mountain Dew, Aquafina and Tropicana and also include ready-to-drink tea products under the joint venture with Unilever.

PepsiCo was founded in 1965 through the merger of Pepsi-Cola and Frito-Lay. Tropicana was acquired in 1998 and PepsiCo merged with the Quaker Oats Company in Aug 2001.

PepsiCo s long-term targets include mid single-digit constant currency net revenue growth, 30 50 basis points (bps) expansion in core operating margins and high single-digit core constant currency earnings growth.

REASONS TO BUY

Strong Brand Recognition: Pepsi is the largest food and beverage business in North America and the second largest in the world. The company is the number two global player in beverages, a global leader in salty snacks and owns an attractive global nutrition portfolio boasting brands like Quaker, Tropicana and Gatorade. The company boasts a diverse portfolio, both geographically and product wise. PepsiCo s overall product portfolio includes 22 billion dollar brands including Pepsi, Mountain Dew, Gatorade, Tropicana, Lay's, Doritos, Cheetos and Quaker which generate more than $1 billion each in retail sales annually. The billion dollar brands account for more than 70% of the company s total revenue.

PepsiCo has the competitive advantage of selling both snacks and beverages which are complementary food categories. Salty snacks and liquid refreshment beverages have extremely high co-purchase incidence more than any other commonly purchased items. The complimentary portfolio results in cost leverage, capability sharing, cross-category promotions and other commercial benefits. Also, the company s gigantic size gives it a scale advantage, in areas such as procurement, IT, back office, joint PepsiCo customer teams and R&D innovation which subsequently improve productivity and margins.

Strong Snacks Business: Pepsi holds the number one position in global snacks with popular brands like Doritos, Cheetos and Lay s. Around half of PepsiCo's sales come from snacks and the other half from beverages. PepsiCo s strong and growing snacks business has largely offset its sluggish beverages business in the past many quarters. The Frito-Lay North American snacks business has delivered consistent solid performance over the last three years. Over time, PepsiCo aims to shift its business mix more heavily toward snacks. Going forward, the company expects two thirds of its growth to come from snacks.

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Aggressive Marketing and Brand Building: Over the years, PepsiCo has grown through product innovation and countered competition successfully through aggressive marketing campaigns. With the increase in marketing investments, the company s market share is improving.

In the first half of 2013, the company announced its plans to significantly step up advertising & marketing (A&M) and R&D investments to strengthen its brands and accelerate product innovations. As part of the plan, the company is boosting in-store merchandising capabilities, effectiveness of go-to-market systems in international markets and identifying new productivity projects. Through 2013, Pepsi s A&M expense ratio has increased 70 bps compared to 2011, and R&D spending has increased over 25% since 2011. These initiatives helped the company deliver an overall healthy performance in 2013 either achieving or exceeding most of its financial goals in the year despite tough macroeconomic environment.

Focus on Innovation: Product innovation plays a huge role in the company s success. The company regularly creates new flavors of existing products alongside maintaining a robust pipeline of new products. 2013 was Pepsi s one of the most successful years ever in terms of product launches. In 2013, Pepsi led the industry with successful product launches, accounting for 9 of the top 50 food and beverage introductions in the U.S.

The company s new product efforts in reduced calorie beverages, non-carbonated beverages and healthier snacks are encouraging. In 2013, Pepsi s nutritious products contributed approximately 20% of its revenues.

In order to re-vitalize cola sales which are suffering due to their high calorie content, the company is testing cola product variations using evolutionary natural sweeteners in various markets. Moreover, lower calorie, naturally sweetened non-cola products are expected to be launched in the U.S. this year. Further, the company intends to grow its nutrition brands like Quaker, Tropicana and Gatorade and offer more products with less sodium to reap benefits from shifting consumer preference toward good-for-you and health and wellness products. Over time, the company s product profile has grown from fun-for-you to a more balanced offering of good-for-you, better-for-you, and fun-for-you products.

The company also invests aggressively in new packaging to shift consumers to more profitable purchases. The company s 24-ounce can for regular and diet Dew are generating good customer response. The company also focuses on premium innovation to drive higher net price utilization. At the premium end, some popular product launches include Quaker Real Medleys hot cereals, Stacy's Gingerbread and Stacy's Cocoa and Lay's Stax potato chips.

The company is also exploring new categories like dairy with the Wimm-Bill-Dann acquisition in Russia, the joint venture with Almarai in the Middle East and Muller Quaker Dairy joint venture in the U.S.

Regular product and packaging innovation in the U.S. has led to improved sales and market share performance for Pepsi.

Strong International Presence: PepsiCo generates more than 45% of its revenues outside the U.S. For the past few years, growth in developing and emerging markets has been outpacing the same in developed markets and the trend is expected to continue for the next 5-10 years. Developing and emerging markets have significant growth potential due to their relatively low per-capita consumption. Another reason is the burgeoning middle-class population with rising income levels which has increased the demand for convenient, on-trend, affordable food and beverages. Moreover, especially for products like salty snacks, many international markets are relatively untapped by the other companies; and hence, PepsiCo still does not face the same level of competition in such categories as it does in the beverages market.

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