PepsiCo

Financial Analysis and Valuation Project – Corporate Valuation

Introduction

PepsiCo was formed through a merger of Frito-Lay and Pepsi-Cola in 1965 and has grown to be one of the largest multinational companies in the world. It is currently a global beverage and food leader and having net revenues of over $65 billion and product portfolio which comprises of 22 brands. These Brands generates over $ 1 billion each in terms of retail sales annually. The company manufactures markets and even sells various salty, sweet and convenient snacks that are based on grains, and non-carbonated and carbonated foods and beverages. It has its operations in 200 nations outside Canada and U.S market. The vision of the company is Performance with Purpose, to deliver financial performance that is top-tier over the long-run though the integration of sustainability into its business strategy while imparting positively on the environment and the society at large (PepsiCo 2015 Annual Report, 5).

The firm faces stiff competition from market leaders who comprises of Coca Cola, Kraft Foods and Dr. Pepper / Snapple. The financial statements for the year 2015 indicates that the company was doing fairly well as compared to competitors since free cash flow that excludes various items shows a strong performance at $ 8.1 billion and the total over the three years ending in 2015 was over $ 24 billion . The performance was also made it possible for the company to raise its annualized dividend for 43^rd year in 2015 consecutively. The firm was also able to return $ 9 billion to its shareholders by way of dividends and share purchases. From the year 2012, the company has been able to return over $ 24 billion to shareholders in form of share purchases and dividends. However, the growth of Pepsi is at par with other main companies making soft-drink more so the Coca Cola (PepsiCo 2014 Annual Report, 5). PepsiCo has been losing its market share to Coca Cola it is still vulnerable to being exposed to carbonates that are slowly growing. The EBIT margin for the company is way below the other competitors as for the year 2015 an exception being in the North America where it draws most of its revenue. Since the year 2013, the company has been trading at the same price earnings multiples with its main competitor Coca Cola with its revenues increasing by about 1.4 percent and EPS at 6.6 percent. Currently, the firm has net income of $ 6,646 Million while Coca Cola net income is $ 7,214 which shows the PepsiCo has been trailing its major competitor in terms of revenue (PepsiCo 2014 Annual Report, 5).

However, the firm has internal strategic factors that serve as its main strengths which includes a product mix that is broad, strong brand image, extensive worldwide production and distributions networks. Being among the successful global brand, the firm is able to attract customers to its products. The extensive product mix indicates the company’s increasing ability to reach a number of markets or segments through products such as Quaker and Frito-Lay brands. The global distribution and production networks help the firm to attain international growth through its expansion strategies. The firms have various weaknesses which prevent its full international growth. The factors that hinders this growth includes low penetration in markets outside America’s, a business portfolio that is limited and challenges in carbonated products to consumers who are health-conscious. By deriving around 70 percent of the revenue from North America and South America markets, it is an indication that the firm has yet to maximize potential revenues in other markets outside the Americans. However, there are various opportunities for the company to continue growing in terms of business diversification, forming alliance with complementary firms globally (PepsiCo 2014 Annual Report, 5). Creation of such alliances will help the firm in increasing its presence in the global market and be able to penetrate the emerging markets so as to increase revenue generation. The firm experiences various threats especially from aggressive marketing, environmentalism and trends on healthy lifestyles.

Historical data analysis

PepsiCo shares traded range- bound for 2015, after improving steadily for the previous 3 years. The sideways performance of the firm’s stock appears to have coincided with earnings underperformance for the same time. The company’s earnings from 2015 third quarter dropped to $ 533 million from the second quarter earnings of $1.98 billion, which represents a decline of over 70 percent. At the time, it seemed unlikely that 2015 earnings would match the $6.51 billion in 2014 in the annual 2015 financial statements (Morningstar.1). The firm’s Price-earnings ratio for 2012 was at 17.11, 18.81 for 2013 and 21.59 for 2014. As for the year 2015, the prevailing figure stood at 28.27, according to earnings information for the period ending on September, 2015. This ratio seems to have been an overvaluation as compared to the price-earnings ratio of 21.59 for year ending 2014, at a time when the firm’s earnings were higher (Morningstar.1). This means that a failure for a rebound in 2016 to the level in 2014 may reduce the price-earnings ratio to about 20.

The operating margins for PepsiCo were between the ranges of 13.91 – 14. 61, for the last 5 years ending in 2015(Morningstar.1). The operating margin for the firm remained steady over that period, even though it trailed the competitors and the average in the industry. For the period ending September 2015, the margin dropped out of 12.64 percent, the previous range, in comparison with 17.11 percent for the entire industry. For 2016, the margin remained within the previous range with the company having no strong growth in sales, similar to the ones in preceding 3 years. PepsiCo generated more sales from the lesser asset base due to diversity in its offerings of complementary products. In comparison, Coca Cola which is major competitor is over 30 percent bigger than PepsiCo in regard to total assets as for the year ended 2014, although its sales were around 70 percent of PepsiCo in 2014, as per the availed financial results. Even though the operating margin for the company was reducing and total earnings were smaller, PepsiCo was still able to achieve better returns on assets in 2014. The returns on assets for 2015 stood at 45 percent which is an increase from 37 percent attained in 2014. The operating margin for 2015 at the same time stood at 14 percent which a decline from 13 percent in 2014. The profit margin for 2015 was 9 percent, slight drop from 2014 which was 10 percent. This illustrates the company continued to experience a decline in the earnings ratios and profitability ratios which does not indicate a good prospective for future performance in relation to the performance in the entire market.

Forecast future CFs

PepsiCo market share is expected to increase to 14.0 percent from about 12.7 percent by the end of 5 years, driven by the efforts to increase diversification in products targeting the health conscious segment of the market. This is in line with increasing with expanding global beverage market especially in the emerging economies. The company’s revenue is expected to surpass 16.03bn, earned in the 3^rd quarter of 2016.

The end of 2016 trading period saw PepsiCo share price end at $ 104.63 with shareholders returns being about 8 percent (Morningstar.1). The company’s performance was fair in comparison with the industry performance and in fact, it outperformed its main competitor Coca Cola. This is in part due to the diversification of its snack food products that its rivals do not have. With a lower dividend yield than its rivals, the company’s performance seems not satisfactory to shareholders. The shares seem to have doubled off in line with its component rival – Coca Cola – at Dow. This would be a call for the firm to break apart the snack foods and beverage section of its business but PepsiCo continue to do better in terms of financial and growth aspects while it remains diversified.

On the basis of the past performance, the company can be expected to grow it earnings at 7.41 percent annual average rate. For the year 2017, the increase in forecast earnings can be 5.0.1 percent above last year’s earnings and expected earnings growth of about 7.7 percent over earnings for casted for 2017. The quarterly reports for 2016 showed good performance in midst of various challenges in the macroeconomic environment that result from increased volatility in emerging economies and an increasingly sluggish demand for consumer products in the developed economies. The expected growth can be attributed to the company’s strengthening presence in emerging economies like Asia, Africa and Middle East whose growth is very promising. Moreover, the prediction aligns to the ICEF Monitor, whose forecasts are three times than that of developed economies, so that cumulative economic growth globally is at 65 percent by 20120

Estimated discount rate

WACC = rD(1-TC)[Weight for Debt] + rP[Weight for Preferred Stock] + rE[Weight for Common Stock]

The risk free rate is placed at 3.01%

As per the financial statement, the capital structures includes: 30.28% - common stock, 0.10% - preferred stock and 69.63 % as debt. The preference stock looks quite negligible. Weighted-average interest rate (cost of capital) =69.63 %( 1‐26.08%) +30.28%*3.0475%

WACC = 52.39%

Equity at fair value = 1,434,183,120 × $104.03 = $149,198,069,973.60

Weighted-average interest rate (cost of capital) = 100 × 1,050/ 33,284 = 3.16%

Expected rate of return = 7.94 percent

Average effective income tax rate= 25.38%

Estimated firm’s value and stock price