Peter Santoro, manager of Columbia Management Advisers’ Large Cap Core Fund, recently picked PepsiCo (NYSE:PEP) as one of two large-cap stocks with very attractive valuations. In an interview with The Wall Street Transcript, Santoro suggested that PepsiCo’s strong balance sheet and emerging-markets potential combined with historically low valuation multiples makes its stock more attractive than ever. While this might be true, I’m going to play devil’s advocate for a moment and give you some reasons why you might want to think twice about owning its stock.
52-Week Low
I’ll give Santoro kudos for picking a stock near its 52-week low. That said, there’s a number of big-name drink stocks, both alcoholic and non-alcoholic, also trading near their one-year lows, so let’s not get carried away. It’s an industry thing.
Besides, PepsiCo’s stock historically has traded in a tight range, so a low one day is a high the next. In the past five years, it has moved between $43.78 and $79.79. That’s a difference of only $36. Currently, it sits smack dab in the middle of that range, so it’s fair to say it could just as easily head lower than higher. I guess that’s why they pay money managers the big bucks.
However, Pepsico’s stock rarely loses more than 20% in any given year, so the likelihood of it running back down to $44 is minimal. The big risk here is the markets moving ahead while PepsiCo doesn’t.
Price to Free Cash Flow
Santoro makes reference to PepsiCo’s historically low valuation multiples. One ratio I use to examine a stock’s value is price to free cash flow. This tells me what investors are willing to pay for a company’s free cash flow.
Currently, they will pay 21.1 times free cash flow compared to 27.1 back in 2007, when PepsiCo hit its five-year high. By this measure at least, it certainly appears less expensive. In 2007, it generated $4.5 billion in free cash from $39.5 billion in revenues. In the trailing 12 months, it generated $4.8 billion from revenues of $62.4 billion. Essentially, it generated $300 million in additional free cash from $23 billion in revenue. That’s not so good.
Furthermore, you can buy Dr. Pepper Snapple Group (NYSE:DPS) and Boston Beer Co. (NYSE:SAM) for 7.7 times and 15.5 times FCF, respectively. The reality is PepsiCo might be cheap in relation to itself, but who out there invests in a bubble? There are other cheaper options available.
Share Repurchases
Part of the free cash flow discussion must include share repurchases. After all, dividends and buybacks are two of the only ways a company can reward its shareholders.
In the past five years, PepsiCo has repurchased $17 billion in stock at an average price of $66.15 per share. Its return on investment is -6.8%. Shareholders will argue that these purchases reduced the share count, thereby increasing earnings per share. That would be the case — if it didn’t issue any new shares. However, in both 2006 and 2007, it issued 31 million shares for stock options. At the end of the day, $17 billion reduced the share count by just 55 million, or 3.3%.
On a good note, any increase in earnings in that time wasn’t from share repurchase sleight of hand. However, I’ll bet you any amount of money that if PepsiCo had paid out the $17 billion in dividends instead of share repurchases, its stock would have gained more than 22% over 68 months.
Bottom Line
PepsiCo might have a pretty balance sheet, but there are plenty of other large caps with good ones, too. Heck, Apple (NASDAQ:AAPL) is Santoro’s top holding, and the last time I checked, it had a decent balance sheet.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
