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Shares of PepsiCo (NASDAQ:PEP) have continued to trade near their highs, having seen relatively limited volatility in a tumultuous year 2022. In February of last year, I concluded that shares were too bubbly for me.
At the time shares were seeing strong demand as PepsiCo was simply executing as the emergence of inflation on the results was seen and anticipated. The higher earnings multiple being awarded meant that the gap with Treasury yield was narrowing in a huge way, as I saw relatively limited appeal.
A Recap
PepsiCo has made some alterations to the business in 2021, reaching a $3.3 billion deal with PAI Partners in which the company sold a majority stake in its Tropicana, Naked and other juice business. The deal was set to create a more focused and better aligned business with healthier and zero-calorie beverages.
Ahead of this divestment, the company was on track to generate about $75 billion in sales with earnings seen around $6.20 per share (based on adjusted earnings). This means that shares traded at 25 times earnings, but that was at $156 per share. The divestment means that net debt should come down to $33 billion, resulting in a leverage ratio in the mid-2s with EBITDA reported at $14 billion. The earnings yield of 4% started to look a bit low in relation to the risk-free alternative, despite a solid (dividend) track record of the business.
This strong performance was to be applauded, but still I was surprised how large parts of the business of PepsiCo were still not really healthy(ier) or better alternatives. For that, I think of large parts of the snacking portfolio, as well as drinks of course. With the earnings yield compressing to 3.6% based on the same earnings numbers and shares having risen to $170 early in 2022, there simply was not a very compelling risk-reward situation in my eyes.
Struggling Along
Over the past year, shares of the company have been trading in a relative tight range between $155 and $185 per share, currently trading hands at $179 per share.
This came as the company posted strong growth in 2022, but in an inflationary environment reported sales growth is not too indicative. Full year revenues were up nearly 9% to $86.4 billion, but that does not say much as beverage volumes were flat and convenient food volumes dropped 2%. This means that growth is driven by pricing, despite some foreign exchange headwinds amidst the impact of a stronger dollar.
Operating profits rose in a much less pronounced manner, up from $11.2 billion in 2021 to $11.5 billion. The company posted a $3.3 billion gain on the Juice transaction, largely offset by a near $3.2 billion impairment charge related to the SodaStream deal and the wind-down of the operations in Russian, as both items largely cancel out. This shows that operating profits were flattish in dollar terms, indicating that margin pressure was seen in relative terms.
On the bottom line the company did see more earnings growth, driven by lower interest expenses and tax rates, with net earnings increasing from $7.6 billion to $8.9 billion as GAAP earnings were reported at $6.42 per share. Adjusted earnings were posted at $6.79 per share, up from $6.26 per share in the year before.
The company ended the year with $5.3 billion in cash and $39 billion in debt, as the resulting $33.7 billion net debt load is quite reasonable, with EBITDA coming in pretty stable around $14 billion.
For the upcoming year, the company sees organic sales up 6%, but the company has not split out this guidance in volumes and pricing, although it indicates that it expects a 2% headwind from the dollar. Core earnings are seen up 8%, with core earnings seen up to $7.20 per share.
The company announced a convincing 51st consecutive increase in dividends, hiking the payout to $5.06 per share, thereby increasing the payout ratio a bit. This is likely the result of the attempt to make the yield compelling enough versus alternatives, as the latest hikes translate into a 2.8% dividend yield, still lagging risk-free alternatives here of course.
And Now?
The reality is that PepsiCo trades at more than 26 times earnings, as multiples are set to fall to 25 times based on this year’s outlook. The resulting 4% earnings yield trails that of risk-free alternatives in a meaningful way. Given that observation, I am surprised to see that shares held up so well, as risk-free rates in Treasuries now exceed the earnings yield of course.
There is a small counterargument to this as that is the negative sloping yield curve, indicating that investors do not believe that current high interest rates will be seen in the long term, and the long term is what investors in PepsiCo are looking after.
The reality is that PepsiCo is a great long-term play, having seen solid organic growth despite a tougher positioning from some health perspectives. What we have seen in 2022 is that volume growth was not delivered upon, as the question is if and how much volume growth is anticipated in the 6% revenue growth outlook for this year.
The company appears to manage inflation well, even if margins are down a bit in 2022. While the company is a great long-term play, the reality is that I am cautious on the back of a 4%, or sub 4% earnings yield, given where interest rates are in this environment. This remains the near to medium-term tactical play, yet the true long-term prospects remain solid, driven by continued execution.
