PepsiCo Valuation, Part 1

This will be the first of a multi-part analysis of PepsiCo. All source data is from Macro Trends. Computed values are in columns with italicized headers.

Year	Revenue	Oper Income	oper margin	Net Income	net margin	Shares
2020	$70,372	$10,080	14%	$7,120	10.1%	1,392
2019	$67,161	$10,291	15%	$7,314	10.9%	1,407
2018	$64,661	$10,110	16%	$12,513	19.4%	1,425
2017	$63,525	$10,276	16%	$4,857	7.6%	1,438
2016	$62,799	$9,804	16%	$6,329	10.1%	1,452
2015	$63,056	$8,353	13%	$5,452	8.6%	1,485
2014	$66,683	$9,581	14%	$6,503	9.8%	1,527
2013	$66,415	$9,705	15%	$6,740	10.1%	1,560
2012	$65,492	$9,112	14%	$6,171	9.4%	1,575
2011	$66,504	$9,633	14%	$6,436	9.7%	1,597
2010	$57,838	$8,332	14%	$6,314	10.9%	1,614
2009	$43,232	$8,044	19%	$5,940	13.7%	1,577
2008	$43,251	$6,959	16%	$5,134	11.9%	1,602
2007	$39,474	$7,182	18%	$5,646	14.3%	1,658
2006	$35,137	$6,502	19%	$5,631	16.0%	1,687
2005	$32,562	$5,984	18%	$4,060	12.5%	1,706

Operating margin is very stable. You can see the effect of the acquisitions of two bottlers, The Pepsi Bottling Group, Inc. ("PBG") and PepsiAmericas, Inc. ("PAS"), in 2009 had the effect that one would have expected, to lower operating margins. Net margin is also stable, and also dropped as one would expect from the bottler acquisitions. Net margin is full. There is likely little slack or room for improvement, at least not at a level that would fundamentally alter a valuation.

Revenues are not growing. I'm ignoring any comparison to 2005-2009, which is before the bottler acquisitions. Revenue was $67K in 2011 and $67K in 2019. Operating income is also mostly unchanged over that same period. Net income, however, appears to have benefitted from some improvements, of roughly $1B per year.

The one area where PEP is seeing steady improvement is share count. PepsiCo has done a good job in shrinking the share count since 2005, as can be seen in the following table, with an annual compounded shrinkage rate of 1.35%.

Year	EPS	Share Holder Equity	ROE	ROE w/ outliers removed	share shrink age
2020	$5.12	$13,552	52.5%	52.5%	1.07%
2019	$5.20	$14,868	49.2%	49.2%	1.26%
2018	$8.78	$14,602	85.7%		0.90%
2017	$3.38	$10,981	44.2%	44.2%	0.96%
2016	$4.36	$11,199	56.5%	56.5%	2.22%
2015	$3.67	$12,030	45.3%	45.3%	2.75%
2014	$4.27	$17,548	37.1%	37.1%	2.12%
2013	$4.32	$24,389	27.6%	27.6%	0.95%
2012	$3.92	$22,399	27.6%	27.6%	1.38%
2011	$4.03	$20,899	30.8%	30.8%	1.05%
2010	$3.91	$21,476	29.4%	29.4%	-2.35%
2009	$3.77	$17,442	34.1%	34.1%	1.56%
2008	$3.21	$12,582	40.8%	40.8%	3.38%
2007	$3.41	$17,234	32.8%	32.8%	1.72%
2006	$3.34	$15,368	36.6%	36.6%	1.11%
2005	$2.39	$14,251	28.5%	28.5%

Average ROE is 41.2%, 38.2% if you remove outlier year 2018 from the calculation. Though this has been raised by years of constant share buybacks, ROE was already excellent in 2005 and the overall record indicates that the business is a frugal user of capital assets, despite the inclusion of bottling and distribution operations.

PEP's use of its generated cash is reasonable, though there are some worrisome signs. Dividend policy 15 years ago might have been compatible with a payout of 40% of earnings as dividends, but in recent years payouts have been more in the neighborhood of 75%. 

Year	Common Stock Dividends Paid	% of income pd as divid	% income avail for reinvest	ROE * reinvest	book	potential add on EPS
2020	$5,509	77%	23%	12%	$10	$0.61
2019	$5,304	73%	27%	14%	$11	$0.70
2018	$4,930	39%	61%	52%	$10	$4.56
2017	$4,472	92%	8%	4%	$8	$0.12
2016	$4,227	67%	33%	19%	$8	$0.82
2015	$4,040	74%	26%	12%	$8	$0.43
2014	$3,730	57%	43%	16%	$11	$0.67
2013	$3,434	51%	49%	14%	$16	$0.59
2012	$3,305	54%	46%	13%	$14	$0.50
2011	$3,157	49%	51%	16%	$13	$0.63
2010	$2,978	47%	53%	16%	$13	$0.61
2009	$2,732	46%	54%	18%	$11	$0.69
2008	$2,541	49%	51%	21%	$8	$0.66
2007	$2,204	39%	61%	20%	$10	$0.68
2006	$1,854	33%	67%	25%	$9	$0.82
2005	$1,642	40%	60%	17%	$8	$0.41

That leaves a lot less cash available for reinvestment, whether it is for upgrade and expansion, acquisition, or buying back shares. As a check, I've calculated what the retained earnings can support in terms of increments in EPS, assuming that ROE is representative of incremental investment. Of course, acquisitions like Sodastream are very unlikely to generate a 38% return on equity, but internal developments like snack innovation might, in limited cases. The creation of the Flamin' Hot snack line is one example. All is well there, and cash flow can support reinvestment.

PEP is clearly showing signs of maturity. It's stable, and based on my quick look at Coca-Cola Co. financials it is in better shape than KO, but it's hardly posting 8% to 10% gains that you want to see from a major dominant food company. 

Valuation then falls to estimates of revenue growth rate and duration. If we set growth at 3-4%, for 25 years, and a gradual decline of 4% annually thereafter, then using pre-COVID discount rates of about 5%, then we get company valuations of $131 to $150, which are pretty close to its recent trading range. If we use a COVID-era (or extended malaise) discount rate of 3%, then PEP is worth $188 to $217.

The hazard of using these valuations is that so far I've treated PEP as a single monolithic business. Sodas may not do so well as snacks. If we analyze the snack, beverage, and food portions of the business separately, we may get a different answer. We will do that analysis in the next essay.