On Thursday, PepsiCo (PEP, Financial) reported financial results for the fourth quarter and full year of fiscal 2020.
For the quarter, organic revenues increased by 6%, with volumes and net pricing both contributing three points. The results reflect mid-single growth in beverages and food / snacks, as well as mid-single digit growth in both North America and International.
For the year, organic revenues increased by 4%, at the low-end of management's long-term targets of 4% to 6% organic sales growth.
Growth in the quarter and throughout the year was led by Quaker Foods North America (QFNA), with organic top-line growth of 8% and 11%, respectively (with segment income up 24% for the year). This strength reflects Quaker's exposure to take-home consumption in categories like breakfast that have benefited during the pandemic.
Frito-Lay North America (FLNA) was another bright spot for the company in 2020, with revenues and operating income increasing by 6% and 3%, respectively (with segment profitability facing a roughly four point headwind from Covid-related costs). As CEO Ramon Laguarta noted on the call, Frito-Lay's largest brands all delivered in 2020:
"Many of Frito's big brands delivered strong net revenue growth for the full year with Tostitos and Cheetos delivering double-digit growth, Ruffles delivering high-single digit growth, while Lays and Doritos delivered mid-single digit growth."
FLNA continues to be the primary business driver at PepsiCo, accounting for 46% of the company's profits in 2020 (compared to 35% a decade ago). As shown below, segment profitability has increased by roughly 60% over the past decade (~5% compounded annual growth rate) due to a combination of revenue growth (~4% compounded) and margin expansion (segment operating margins have expanded by a total of 200 basis points since 2010).
Despite the 4% increase in organic revenues, adjusted operating income declined marginally during 2020 to $10.5 billion, with core operating margins contracting by roughly 80 basis points. This primarily reflects the roughly $800 million in Covid-related costs incurred throughout the year. As a result, core constant currency diluted earnings per share (EPS) were up 2% in 2020 to $5.52 per share.
Free cash flow in 2020 was $6.4 billion, an increase of 18% (helped by outsized pension contributions in 2019).
For the year, the company returned $7.5 billion to shareholders, with $2.0 billion in repurchases and $5.5 billion in dividends (the company also announced a 5% increase in the 2021 payout, the 49th year in a row that PepsiCo has increased its per share dividend). Capital returns to shareholders are expected to fall to $5.9 billion in 2021, with the biggest difference from prior years being nascent repurchases (the company plans for just $100 million, which they've already completed). As shown below, this decision reflects the reality that PepsiCo's balance sheet positioning has weakened over the past few years.
A look at the past decade is instructive: from 2011 to 2020, PepsiCo generated roughly $66 billion in free cash flow. From there, dividends and repurchases were an outflow of $42 billion and $31 billion, respectively. In addition, acquisitions totaled roughly $13 billion over the past decade. The net result has been that long-term debt has roughly doubled to $40 billion since the end of 2010 compared to an increase of only ~20% for net income over the same period. The end result is a meaningful increase in financial leverage – and the need to take a foot off the gas in the short-term.
Conclusion
PepsiCo has done a good job navigating short-term pressures during the pandemic. The fact that they still managed to deliver mid-single digit organic sales growth in 2020, despite facing large headwinds in key end markets (C-stores and foodservice), is impressive.
Looking ahead to 2021, management expects a mid-single digit increase in organic sales and a high-single digit increase in core, constant currency EPS. On the latter metric, that implies earnings of roughly $6 per share; at $134, the stock trades at roughly 22 times forward earnings.
As I've discussed previously, I sold PepsiCo in October 2018 to fund an investment in Facebook (FB, Financial). Since that time, both companies have seen a slight increase in the valuation multiple applied by Mr. Market. The difference is that Facebook's EPS has increased by roughly 60% since then (comparing 2018 to 2021), while Pepsi's EPS has increased by less than 10%. As a result, Facebook shares are up ~75% since October 2018, while PepsiCo shares are up ~20%.
Thus, the opportunity cost of owning PepsiCo is too high for me at current levels. That said, given the current interest rate environment, I can appreciate why this is a good choice for individuals looking for "safe" alternatives that are highly likely to outpace long-term bonds over the next five to 10 years. For that reason, it's unlikely that I would invest in PepsiCo unless shares were much cheaper.
Disclosure: Long Facebook
Read more here:
- Yelp: Despite a Tough 2020, There Is Reason for Optimism
- Under Armour: Are the Clouds Parting?
- Fox: Tougher Comparisons in 2021
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