A first look at PepsiCo after activist activity
One of the largest and most successful activist investors is at it again...
Earlier this month, Elliott Investment Management announced that it had taken a roughly $4 billion stake in beverage and snack giant PepsiCo (PEP). It released a 75-slide presentation pushing for many changes.
As the Wall Street Journal reported last week, Elliott sent a letter with its ideas to PepsiCo's board of directors. And the activist investor believes that the changes could boost PepsiCo's stock by at least 50%. Here's an excerpt from the WSJ article:
[Elliott] suggested PepsiCo consider refranchising its bottling network, leaving ownership in the hands of local and independent bottlers. (Rival Coca-Cola completed a large-scale refranchising initiative in 2017. The Fanta and Powerade owner now has a market value of nearly $300 billion, with its share price near all-time highs.)
Elliott also encouraged PepsiCo to review both its beverage and food offerings and eliminate those that don't sell well. The firm also said PepsiCo should provide investors with more specific plans to improve its results.
PepsiCo needs little introduction. It's a household name. And it's a very high-quality business. Meanwhile, Elliott has a long track record of successful activism.
That's enough to put PepsiCo on my radar. So today, let's check out the company's financials with my usual "first look" analysis...
For some context on the stock, take a look at the long-term chart below. As you can see, PepsiCo grew steadily over the years until it peaked in early 2023. Since then, the stock has lost roughly a quarter of its value:
With that context, let's check out the financials...
As always, I start with a long-term look at revenue and profit (in this case, I use operating income):
You can see a long track record of growth. But you'll also notice extended periods of stagnation. There's one period from 2011 to 2020 and another over roughly the past two and a half years.
The cash-flow statement shows steady free cash flow ("FCF"). However, this metric has barely budged since the early 2010s. Here's the chart of PepsiCo's operating cash flow, capital expenditures ("capex"), and FCF:
Next, the balance sheet shows that PepsiCo has taken on more and more debt over roughly the past two decades. As of the most recent quarter, debt comes in at about $43.4 billion:
This isn't a dangerous amount, since PepsiCo's debt is equal to about 2.8 times trailing earnings before interest, taxes, depreciation, and amortization ("EBITDA"). But the trend is concerning.
To understand why debt is rising despite large amounts of FCF, let's see how the company is using its cash:
We can see that PepsiCo prides itself on its dividend (the stock currently yields about 4%). And the dividend has grown for a remarkable 53 consecutive years. However, PepsiCo isn't generating the FCF to cover it...
Over the past year, FCF was about $7.1 billion. This is less than the roughly $7.5 billion that the company paid out in dividends over the same time frame.
As recently as 2015, PepsiCo's FCF was more than double its dividend payout. And that gave the company the flexibility to buy back large amounts of stock.
However, share repurchases have slowed to a trickle over the past decade – such that the diluted share count only fell by 7.5% versus 12.0% during the prior decade. Take a look at this next chart:
Lastly, debt has risen because PepsiCo has spent about $23.2 billion of cash on acquisitions over roughly the past two decades.
Turning to valuation...
As of yesterday's close, PepsiCo has a market capitalization of about $196 billion. Adding in the roughly $43 billion of net debt, the enterprise value is roughly $239 billion.
PEP shares closed yesterday at $143.10. And consensus analysts' estimates for earnings per share are $8.02 this year (down from $8.16 last year) and $8.50 next year. As such, the stock is trading at about 17.8 times this year's earnings and 16.8 times next year's.
That's a below-market multiple. But it looks warranted in light of the stagnant growth.
In summary, PepsiCo is an outstanding business that generates massive amounts of FCF. But I don't think the stock will move unless the company can show meaningful growth.
Could Elliott's ideas be a catalyst for this? That's what I'll examine in tomorrow's e-mail... So stay tuned!
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.