It Is Time To Start Investing Pepsi Stock Dividends Elsewhere

  • Pepsi believes that currency headwinds will only impact 2016 revenues by 4%. Sounds optimistic to me.
  • The US could be entering a recession which would be bearish for Pepsi's growing domestic divisions.
  • Volatility in commodity prices is a risk as Pepsi only has 75% of its raw material costs hedged.

PepsiCo (NYSE:PEP) is a true dividend aristocrat having increased its dividend for the last 44 years. Its latest increase means that the company's annualized dividend is currently $3.01 which equates to a 7% increase in the dividend payout. If you are a long term holder of Pepsi stock, I am not advocating selling Pepsi at present but it may be a good idea to start redistributing the dividends to other stocks which have had their valuations more beaten up in recent times. Pepsi, for example, looks expensive with its present earnings multiple of 27+ which is well above its 5 year average of 19.6. So why should the stock deserve such a high valuation considering the fact that the company's 2015 revenue is a good $3.5 billion shy of 2011 numbers?

Well, Pepsi's fourth quarter earnings definitely helped the matter as adjusted earnings matched analysts expectations. The beverage company expects to achieve organic revenue growth of 4% in 2016 through more acquisitions in the health and wellness areas, elevated market spend and more investment being ploughed back into its brands. There is no doubt the company has the balance sheet to carry out these initiatives in 2016. Pepsi has over $12 billion of cash and cash equivalents on its balance sheet at present while long-term debt spiked to almost $30 billion in 2015. Therefore the question becomes "Can Pepsi continue to invest through the cycle and come out on the other side with sustained top line growth once more ?" It is certainly possible but there may be ramifications that dividend investors should know.

Firstly, the dollar is going to be crucial for Pepsi's fortunes in 2016. Almost 45% of the company's organic revenues come from its international markets so the strength of the dollar in 2016 is going to have a major impact on the company's top line. What I find overly bullish is that the company is guiding flat revenues in 2016 (4% organic growth being offset by -4% currency headwinds). Why do I find this overly optimistic? Well, just look at the company's earnings numbers last quarter. Granted that the dollar was exceptionally strong in the fourth quarter of 2015 but organic growth was affected by a whopping 8%! If the dollar stays anywhere near these levels, Pepsi will be doomed to another year of falling revenues in dollar terms which means the company will be forced to lower its guidance. Furthermore, when you combine falling revenues with elevated spend, that's when dividend growth rates and buybacks get squeezed even if the share price remains elevated right throughout the cycle.

Secondly, what few analysts talk about is the risk of a slowdown in the US which would adversely affect Pepsi's domestic divisions. FritoLay & North American Beverages grew robustly last quarter (2% and 1.9% growth respectively) and these divisions make up well over 50% of the company's revenues so they are crucial to Pepsi's revenue expectations for 2016. However, just look at the recent economic data that has come out of the US. The manufacturing sector is on its knees, corporate profits are now down 5 quarters in a row and the service sector is also contracting. Having said this, the US seems to be the strongest economy at present which should keep its currency elevated against other international currencies. It would be disastrous for Pepsi to see negative revenue growth in the US plus a sustained strong dollar. This would wipe billions off its top line in 2016 which, in my view, is a distinct possibility at this stage.

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Commodities is also an area where this company may be vulnerable. Pricing on raw materials such as wheat, corn, aluminium, etc is essential to keep sales elevated and profits growing. However, the beverage and snacks company only hedges 75% of its commodity needs meaning that it is somewhat open to price volatility in this sector. Corn and wheat prices, for example, have been in a bear market since 2011 and it would be immature to believe that this will continue going forward. Again if commodity prices were to rise (but the dollar remained strong), Pepsi's margins would definitely be impacted adversely. Missing the guidance will mean the company's payout ratio will increase even more (80% currently) which wouldn't bode well for meaningful dividend increases in the future.

To sum up, Pepsi stock is trading at a rich valuation and is guiding for flat revenues for 2016 which is overly optimistic in my view. There are just too many variables. First, you have the dollar which will remain a headwind if it stays at these levels. Then you have fears of a US recession that would potentially decrease the demand for its products and you also have commodity prices which for the most part have been in a bear market since 2011. If these rise meaningfully, they will put pressure on Pepsi's top line and profitability. My recommendation would be to re-invest Pepsi's dividends into other dividend stocks with lower valuations and better fundamentals.

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Author's Disclosures & Disclaimers:
  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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