PepsiCo (NYSE:PEP) stock rose sharply on Friday after the global beverage and snacks giant reported fourth-quarter numbers that were largely in-line with expectations, but provided full-year 2019 revenue guidance that impressed investors. Pepsi stock rose more than 3% in the wake of the results.
From a big-picture perspective, Pepsi is doing everything right. It’s expanding its beverage-product portfolio to include brands and products which resonate better with today’s health-conscious consumers than traditional sodas. It’s also doubling down on its push into the snacking category, which includes broadening the portfolio to include more health-conscious, relevant brands. And as far as operations, everything looks good at PEP.
Meanwhile, the macroeconomic backdrop is stabilizing. Pepsi stock is also cheap both on an absolute basis and relative to shares of Coca-Cola (NYSE:KO).
Thus, this rally of PEP stock makes sense. Good results, improving sentiment, and a depressed valuation will push Pepsi stock above $120 soon.
Pepsi’s Strategy Is Effective
In Q4, PEP reported sales growth, excluding acquisitions, of 4.6% and core earnings per share growth of 17%. That wraps up a year during which its sales excluding acquisitions rose 3.7% and its core EPS rose 9%. That was the third consecutive year that its sales excluding acquisitions rose 2%-4% range and its core EPS rose 9%.
What has PEP done right during those three years? It has successfully broadened its reach and portfolio. We all know that the traditional carbonated beverage market is stagnant and perhaps even declining as consumers increasingly shift towards healthier options, like enhanced waters, sparkling drinks, and teas.
PEP has made this pivot, too. Specifically, it made acquisitions, headlined by its $3.2 billion acquisition of SodaStream last year, and PEP has also made its existing beverage brands more relevant and healthy.
Pepsi has made a similar pivot in the snacking category. Much like traditional sodas, traditional, sugar-heavy snacks are losing popularity as consumers shift towards healthier options. Mostly through acquisitions, such as the late 2018 acquisition of plant-based-snack-bar-brand Health Warrior, Pepsi has made its snacks exceptionally relevant to today’s health-conscious consumers.
This strategy of acquiring relevant, popular snack and beverage brands, and distributing them around the world, is a winning combination. For the foreseeable future, the strategy will generate largely consistent, low-single-digit-percentage-revenue growth for PEP. Coupled with cost-cutting measures, that top-line growth should enable Pepsi’s EPS to steadily rise by mid-to-high-single-digit-percentage levels.
The Valuation of Pepsi Stock Is Attractive
The attractive thing about PEP stock is that, because everyone piled into KO stock in 2018 and forgot about Pepsi stock, the shares of Pepsi are still undervalued even after their post-earnings pop.
Consider this. KO stock almost always has a higher forward price-earnings multiple than Pepsi stock. But the divergence between the forward multiples of KO and PEP s is currently at a multi-year high. Whenever the difference between the forward P/E multiples of the two stocks is above two(which it currently is), PEP stock tends to outperform.
Also, Pepsi almost always has a lower dividend yield than KO stock. But, for the first time in five years, PEP’s dividend yield is almost as big as KO’s dividend yield.
In other words, relative to KO stock and historical standards, PEP stock seems undervalued. That is also true on an absolute basis. Assuming Pepsi’s mid-to-high-single-digit-percentage EPS growth persists, Pepsi’s EPS could be $8.50 by fiscal 2025. Based on Pepsi stock’s average historic forward multiple of 20, that equates to a fiscal 2024 price target of $170.for PEP stock Discounted back by 7% per year (three points lower than my usual 10% discount rate to account for the yield), that equates to a fiscal 2019 price target of over $120.
The Bottom Line on PEP Stock
PEP has found a winning strategy which should power consistent, healthy revenue and profit growth over the next several years. As a result, Pepsi stock is a good name to buy when its valuation is below normal and a good name to sell when its valuation is above normal.
Right now, the valuation of PEP stock is below normal, so now is still a good time to buy it.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
