Stock of the week - PepsiCo (05.10.2023)

• PepsiCo is set to report Q3 2023 earnings next week
• Company has a long track record of beating EPS estimates
• Focus on pricing as volume growth stagnates
• A look at valuation
• Stock bounced off the lower limit of bullish channel

Share price of PepsiCo (PEP.US), US snack food and beverage company, has been trading under pressure for the past two months, dropping over 10% off the July high. The company is set to report Q3 earnings next week and given that it has a good track record of beating market expectations, it could be a turning point. Let's take a look at what the market expects and how the company's valuation looks!

PepsiCo reports earnings next week!

PepsiCo (PEP.US) is scheduled to report earnings for Q3 2023 next week on Tuesday, October 10 before opening of the market session. PepsiCo will be one of the first US companies to report earnings for the July-September period. 

Company is expected to report a 9.4% YoY jump in adjusted EPS and 6.5% YoY increase in revenue. It would be a slightly slower EPS growth than 10% YoY reported in a year ago quarter and also slower revenue growth than 8.8% YoY reported in Q3 2022. However, operating margin is expected to improve slightly compared to a year ago. An important point to note is that volume growth is expected to be negative therefore increase in revenue will come entirely from price increases. However, it should be said that PepsiCo has a very solid track record of beating market expectations and have managed to report a better-than-expected EPS for 18 consecutive quarters!

Q3 2023 earnings expectations

• Adjusted EPS: $2.16 (+9.4% YoY)
• Revenue: $23.4 billion (+6.5% YoY)
• Adjusted Operating Income: $3.87 billion (+7.7% YoY)
• Adjusted Operating Margin: 16.6% vs 16.4% a year ago
• Organic Revenue Growth: +8.3% YoY
• Organic Volume Growth: -1.1% YoY

Growth in PepsiCo's organic revenue has been driven primarily by favorable pricing mix in recent quarters. Source: xStation5

Valuation

Let's take a quick look at PepsiCo's valuation with 3 often used valuation methods - DCF, multiples and Gordon Growth Model. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices.

Discount Cash Flow method

Let's begin our look at PepsiCo's valuation with the Discounted Cash Flow method (DCF). We have taken a simplified approach and used 5-year averages as assumptions in the model for the 10 years of forecasts. For terminal value estimation we have used a 5-year average Weighted Cost of Capital (WACC) of 6.49% as well as 3.5% terminal revenue growth assumption. Model with such assumptions estimates the intrinsic value of PepsiCo shares at $201.10 per share - or around 19% above yesterday's closing price.

However, as is usually the case with valuation models, DCF model is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: XTB Research

Source: XTB Research

Multiples

Next, let's take a look at multiples of PepsiCo and its peers. Chosen peer group is not entirely homogeneous as PepsiCo's business is almost 50-50 split between snack food and beverages. Having said that, we have included PepsiCo's major peers from both industries (some of them are operating in both). The group includes Coca-Cola, Nestle, Mondelez International, Monster Beverage, Keurig Dr Pepper, Campbell Soup and General Mills. 

Mean and median for 6 multiples were calculated - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA. As means tend to be distorted by outliers, like for example Monster Beverage in this case, we have decide to calculate PepsiCo's valuations using medians. As one can see in the table below, range of obtained valuations have is really wide - from $45.78 in case of P/BV to $209.02 in case of EV/Sales. Taking a trimmed mean of those valuations (excluding the highest and the lowest valuation) leads us to a valuation of $157.84 per share - or around 6.5% below yesterday's closing price.

Source: Bloomberg Finance LP, XTB Research

Gordon Growth Model

As a company with a long and solid track record of sharing profits with shareholders via dividends, PepsiCo can be valued using Gordon Growth Model. PepsiCo has been increasing its dividend for 51 consecutive years already. Quarterly dividend for 2023 has been increased by 10%, from $1.15 to $1.265. This amounts to the annual dividend of $5.06 per share. While the dividend was increased by 10% this year, this is an above-average increase and the company's dividend growth in recent years was closer to 6%. Using an 8.5% as required rate of return (5-year average cost of equity) as well as annual dividend of $5.06 and dividend growth of 6.0% as inputs for Gordon Growth Model leads us to PepsiCo valuation of $214.54 per share - or 27% above current market price.

Source: XTB Research

A look at the chart

Last but not least, let's take a look at PepsiCo (PEP.US) chart at D1 interval. We can see that the stock has been trading under pressure recently, dropping over 10% off the July highs. Nevertheless, bulls managed to halt sell-off at the $168.00 support zone, where the lower limit of the bullish channel can be found. This is a bullish development but it should be noted that it was allowed by an overall improvement in risk appetite yesterday, thanks to a pullback in yields. Company's share price is likely to continue to be driven by market-wide factors until Tuesday next week when company-specific factors (Q3 2023 earnings) will play a bigger role. Should the company once again beat market expectations, triggering upward pressure on its share price, the near-term resistance zone to watch can be found in the $176.00 per share area.

Source: xStation5