Where is PEP’s bargain price?

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If the market’s uncertainty, as seen so far in a rough start to October that has seen the S&P 500 drop almost 5% from its last peak in mid-September, is any indication, the time might be right to start thinking seriously about readjusting your investing strategy. This is especially true if you’ve been riding the market’s long-term upward trend by focusing on growth-oriented stocks that are trading at or near to the top of their historical ranges.

One of the places a lot of investors, myself included, like to focus on when a defensive-oriented approach might be smart is on Food stocks. That includes companies like Pepsico Inc. (PEP). Given consumer trends that have lately driven traditional Food manufacturers like Campbell Soup (CPB), Kraft-Heinz (KHC), and others to find ways to expand or even reinvent their product lines to include more organic and healthier options, it might seem a little ironic to think about a Beverage stock as defensive. That trend, however hasn’t kept PEP from increasing in value since May of 2018 by about 43%. The increase in price, of course, doesn’t mean the stock is a smart defensive investment; but it is illustrative of the fact that even as American consumers may generally be trying to eat and be healthier, they still like their soft drinks.

If the economy, and the market, does finally bow to bearish pressure, stocks like PEP and Coca-Cola Co. (KO) could be useful alternatives to the normal “flight to quality” mindset that drives a lot of investors to low-yield instruments. These are stocks whose global footprint provide a stable revenue base to work from that tends to remain stable in any economic condition. The stock itself could drop in a bear market, of course; but in last year’s near-bear-market test of the last quarter, PEP was one of the few stocks in the market that didn’t see declines of 20% or more. That fact is a good example of the stock’s ability to be resilient even in strongly bearish conditions. From that point, the stock is up about 25%, and that does mean that the stock isn’t likely to offer a very good value proposition; does that translate to increased risk, or is it just a reference point to pay attention to if the market does actually turn bearish? Let’s find out.

Fundamental and Value Profile

PepsiCo, Inc. is a global food and beverage company. The Company’s portfolio of brands includes Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. The Company operates through six segments: Frito-Lay North America (FLNA), Quaker Foods North America (QFNA), North America Beverages (NAB), Latin America, Europe Sub-Saharan Africa (ESSA), and Asia, Middle East and North Africa (AMENA). The FLNA segment includes its branded food and snack businesses in the United States and Canada. The QFNA segment includes its cereal, rice, pasta and other branded food businesses in the United States and Canada. The NAB segment includes its beverage businesses in the United States and Canada. The Latin America segment includes its beverage, food and snack businesses in Latin America. The ESSA segment includes its beverage, food and snack businesses in Europe and Sub-Saharan Africa. The AMENA segment includes its beverage, food and snack businesses in Asia, Middle East and North Africa. PEP has a current market cap of $191.4 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined by about -1.9%, while sales increased about 4.25%. In the last quarter, earnings increased modestly, at 1.3% while sales were about 4.5% higher. PEP operates with a very healthy margin profile that could be showing signs of deterioration; in the last twelve months, Net Income was 18.77% of Revenues but declined to 12.2% in the last quarter.

Free Cash Flow: PEP’s Free Cash Flow is generally healthy. Over the last twelve months, the company generated cash flow of $6.16 billion. That number did decline from March of this year at about $7.1 billion. The current Free Cash Flow translates to a Free Cash Flow Yield of 3.19% at the stock’s current price.

Debt to Equity: PEP has a debt/equity ratio of 2.0, which is high, but not unusual for stocks in the Beverages industry. Their balance sheet shows $5.9 billion in cash and liquid assets versus $29.6 billion in long-term debt. While cash and liquid and assets have declined since March of 2018 from more than $20 billion, their operating profile and balance sheet indicate that PEP should have no trouble servicing its debt.

Dividend: PEP pays an annual dividend of $3.82 per share, which at its current price translates to a dividend yield of about 2.78%.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for PEP is $10.20 per share. At the stock’s current price, that translates to a Price/Book Ratio of 13.45. Their historical average Price/Book ratio is 11.35, suggesting that the stock is more than -15.6% overvalued at its current price, and putting a “fair price” value at around $92 per share.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above displays the past two years of price activity for PEP. The red line traces the stock’s upward trend beginning in May of 2018 to its peak about a week ago at around $140.50 per share. The stock is just a few dollars below that level now, with nearest support around $135 per share, and than about $133.50 below that. If the stock does drop below $133.50, it could retrace as far as the 38.2% Fibonacci line, which is sitting at around $123 before finding new sustainable support. The stock’s resistance is right at its recent high about a week ago at $140.50; a break above that level could see the stock rally to around $143 or $144 in the near-term, based on the distance between the stock’s last resistance break in late August above $133.50 to its next peak at about $138 per share.

Near-term Keys: From a long-term perspective, there really isn’t any way to think of PEP as a bargain at its current price. Given some of the stock’s fundamental metrics, including declining Free Cash Flow, Net Income, and cash, I think the stock might offer even more risk than its Price/Book ratio suggests. That said, I think there are some interesting opportunities to take advantage of changes in the stock’s current momentum and trading range. A break above $140.50 could be an interesting opportunity to take advantage of buying the stock or working with call options with a short-term eye on $144 as an exit point, while a drop below $135 – or, even better, below $133.50 – could be a useful signal to think about shorting the stock or working with put options with an eye on the 38.2% Fibonacci line at around $124 to close that trade.

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