I hate to burst everyone’s bubble, but I was not as impressed with PepsiCo, Inc. (NYSE:PEP)‘srecent earnings as apparently the market was. With the stock up 5.6% from its price before earnings, it makes sense to examine what makes this company worth an extra $6 billion in market capitalization. I hate to say it Pepsi fans, but there are three issues that Pepsi still hasn’t solved.
High Priced Beverages
If there is one thing I’m sure of, it’s that there are no bargains in the beverage bin of the stock market. In fact, I would argue that the only more expensive corner of the market is the utilities industry. Both of these industries I believe are being Dr Pepper Snapple Group Inc. (NYSE:DPS)iven by uninformed investors seeking yields they can’t get elsewhere.
If you ask the average investor about safe investments, you’ll likely get stocks from the utilities segment and the beverage segment. Specifically, I’ll bet you would heard The Coca-Cola Company (NYSE:KO), PepsiCo, and Dr Pepper Snapple Group Inc. (NYSE:DPS) mentioned. If you talked to an investor more focused on growth stocks, you might hear these companies along with Monster Beverage Corp (NASDAQ:MNST).
There are two problems in the beverage industry today. First, the growth rate in volumes is slowing down across the board. Second, investors think they are buying safe stocks with better than average yields, but may not realize the risk they are taking on. Most of these companies are expected to grow at a rate significantly slower than just five or ten years ago, yet investors are paying up for the shares like nothing has changed.
High Prices Apparently Don’t Apply To Just These Stocks
Looking through PepsiCo, Inc. (NYSE:PEP)’s earnings, one thing that jumped out at me was the company’s reported revenue and earnings versus what they called “core constant currency” results. For instance, reported net income was actually down 3%, but PepsiCo, Inc. (NYSE:PEP) said that core EPS was up 12%. I think these adjusted results are designed to mask the company’s real challenges of slow organic growth.
For instance, the company’s Latin American results were driven by a 13% price increase and just 1% of volume growth. This huge price increase isn’t likely repeatable. By comparison, The Coca-Cola Company (NYSE:KO) saw 4% volume growth in Latin America. The bottom line is, Coca-Cola had four times the real growth in Latin America.
Problems At Home
One problem PepsiCo, Inc. (NYSE:PEP) doesn’t seem to have an answer for is, how to grow their North American business. Look at a comparison of Pepsi’s results versus their competition:
| Company | Carbonated Volume | Non-Carbonated Volume |
| PepsiCo | Down 1% | Down “mid-single digits” |
| Coca-Cola | Up 3% | Up 6% |
| Dr. Pepper Snapple | Flat | Down 5% |
| Monster Beverage | Up 17.6% | Up 17.6% |
(Monster Beverage Corp (NASDAQ:MNST) participates in both carbonated and non-carbonated but doesn’t break down volume growth from each segment. This 17.6% increase is the total case volume increase in their last quarter.)
As you can see, PepsiCo seems to be underperforming virtually all of their competition in both the carbonated and non-carbonated beverage business.
Another ongoing issue with PepsiCo, Inc. (NYSE:PEP) is, they don’t seem to understand that Quaker Foods is slowing them down. This division finally turned in slightly positive revenue growth, but was the slowest growing division of the bunch. Selling Quaker Foods would both improve PepsiCo’s growth rate, and would give the company proceeds to shore up their balance sheet.
The Only Half Worth Buying
The bottom line is, half of this company is doing great and that half is known as Frito-Lay. Domestically, Frito-Lay saw volume up 4% in North America, 1% in Latin America, and 15% growth in PepsiCo’s international growth regions. Frito-Lay has been driving results and constantly propping up the lagging Pepsi beverage business.
If Frito-Lay were a separate company, this investment would be a no brainer. However, unless that occurs, PepsiCo just looks overpriced along with its industry. The company’s 2.6% yield and 8.9% expected growth rate as very similar to The Coca-Cola Company (NYSE:KO), but both companies sell for forward P/E ratios that are more than double their growth rates. While you could argue that these multiples are deserved based on each company’s strong history, their slowing future growth argues for multiple compression.
Dr Pepper Snapple Group Inc. (NYSE:DPS) offers investors an even worse deal, with a slightly better yield at 3.18%, but selling for almost 3 times its growth rate. Dr Pepper Snapple Group Inc. (NYSE:DPS)’s focus on carbonated beverages when that industry is slowing the most is particularly troubling. Even the formerly strong Monster Beverage Corp (NASDAQ:MNST) has struggled with earnings growth recently. The company’s use of promotions and discounts threatens to derail the company’s earnings. Analysts are calling for 19% EPS growth in the future, but based on the last few quarters, this goal looks unattainable.
Investors looking for a good yield have bid these stocks up under the assumption that they can’t lose. While the whole industry looks overpriced, PepsiCo, Inc. (NYSE:PEP) has multiple issues that it still hasn’t found a solution for. Frito-Lay is dragging the rest of the company along. Management either needs to find a way to grow the domestic beverages business, or the right thing to do is spin off Frito-Lay. It seems like that is the half investors are paying for anyway.
The article Half Of This Company Is Doing Great originally appeared on Fool.com is written by Chad Henage.
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