DRIP PORTFOLIO
What's Pepsi Worth?

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By Jeff Fischer (TMF Jeff)
June 9, 2000

We asked you to tell us what you thought Drip Port should buy next and the votes have been rolling in. We'll keep the poll open over the weekend as well. As of Friday morning, here's how you voted. You believe that Drip Port should buy:

  • Coca-Cola (NYSE: KO): 27%
  • PepsiCo (NYSE: PEP): 53%
  • Wrigley (NYSE: WWY): 10%
  • A different food and beverage company: 2%
  • No food and beverage company at all: 7%

    To learn why some Fools don't care to invest in the industry at all, visit the Drip Companies discussion board from the past two days. We've held an active dialogue on the issue beginning with the posts titled "Re: Poll: What Should Drip Port Buy?" And if you haven't voted yet, be sure to cast your vote this weekend. Here's the poll.

    Now, leading with 53% of the vote, today we'll consider a final factor regarding PepsiCo: its potential return based on a discounted cash flow model.

    We have discussed Pepsi's valuation in the past, but we haven't run it through a model of what could potentially happen in the next two decades. As always, discounted cash flow (DCF) models are speculative creatures that assume consistent results of one kind or another. They are almost never entirely predictive, so they are best used as merely suggestive models.

    Admitting these limitations, we'll run a loose model over Pepsi just to see where it lands. Last year, we ran similar models on Pfizer (NYSE: PFE) and Johnson & Johnson (NYSE: JNJ) and they showed Pfizer to be very interesting at $32 per share (it's now up 37% to $44) and Johnson & Johnson looked best for us at around $74 per share -- at that price, we have a better chance of achieving a 15% return with J&J. So, we have bought J&J at those prices when possible. (For details on how to run these models, see the past columns: Pfizer and J&J .)

    When you run DCF models, the discount rate that you use is typically that same as your expected (or hoped for) rate of return. As we did in J&J's case, we'll make this 15%. You also need to assume your company's long-term growth rate. The next three years are expected to be stronger than usual at Pepsi, but after that we'll go with an 11% rate of growth in its free cash flow. So, the following is our assumed discounted free cash flow value that will be created at Pepsi over 18 years:

           Free Cash            Discounted
    Year     Flow      Growth     Value
    2000    $2.176b     14%      $1.892b
    2001     2.458      13%       1.858
    2002     2.753      12%       1.810
    2003     3.084      12%       1.763
    2004     3.423      11%       1.701
    2005     3.800      "         1.642
    2006     4.218      "         1.585
    2007     4.682      "         1.530
    2008     5.197      "         1.477
    2009     5.769      "         1.426
    2010     6.403      "         1.376
    2011     7.108      "         1.328
    2012     7.890      "         1.282
    2013     8.757      "         1.237
    2014     9.721      "         1.113
    2015    10.790      "         1.153
    2016    11.977      "         1.112
    2017    13.294      "         1.074
           ---------            --------
    Sum      N/A            $26.359 billion
    

    We get $26.359 billion in value as of 2017.

    We now need to add a "continuing value" to the model, because Pepsi will not simply stop to exist after 2017 (unless health activists come to rule the world). To calculate a continuing value, we multiply the free cash flow in 2017 by 11% to arrive at $14.756 billion. We now divide this number by the difference between our discount rate and our growth rate (which is 0.15 - 0.11 = 0.04). Divided, we get $368.908 billion in continuing value. We need to discount this massive value by 15% as of year 18. Doing so, we get $29.809 billion in terminal value.

    We add this $29.809 billion in terminal value to our $26.359 billion in year 2017 value for a total value of $56.168 billion. We now divide this number by Pepsi's 1.496 billion diluted shares outstanding. Doing so, we arrive at a value per share of $37.54.

    So, our model assumes that in order to achieve a 15% average annual return with Pepsi, we should not pay more than $37.54 per share. Today, the stock trades surprisingly close to that price. With a market cap of $62.8 billion, Pepsi trades at $42, or 11.8% above $37.54. (When we ran a similar model on Wrigley, we found that we needed a share price of about $60 for a 15.5% return. The stock is currently around $80.)

    Remember that our model assumes that Pepsi will grow free cash flow 11% annually indefinitely, so there is certainly a significant chance for the model to fail us! That said, this model provides a suggestive valuation for Pepsi today, and that's all we were seeking. In conclusion, the model suggests that Pepsi may be a reasonable value proposition to us and -- with dollar cost averaging on our side the next two decades -- this business may be one that we can comfortably begin buying.

    We'll continue this discussion next week. It's your turn now: What do you think? Post your thoughts on the Drip Companies discussion board and don't forget to vote, too, if you haven't!

    --Jeff Fischer, TMF Jeff on the boards

  • Drip Portfolio

    6/9/2000 Closing Numbers
    Ticker Company Day Chg % Chg Price
    CPBCAMPBELL SOUP-1/2-1.58%$31.06
    INTCINTEL CORP7/80.69%$127.06
    JNJJOHNSON & JOHNSON1/41.47%$86.13
    MELMELLON FINANCIAL CORP-7/16-1.11%$38.88

      Day Week Month Year
    To Date
    Since
    7/28/1997
    Annualized
    Drip .33% -3.77% .27% 24.76% 62.08% 18.33%
    S&P 500 -.32% -1.37% 2.56% -.84% 55.19% 16.55%
    S&P 500(DA) -.32% -1.37% 2.56% -.84% 57.82% 17.24%
    S&P 500(DCA) n/a n/a n/a n/a 26.59% 8.57%
    NASDAQ 1.29% 1.61% 13.94% -4.78% 146.87% 37.02%

    Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
    9/8/199722.9859INTC45.653$127.06178.32%
    11/5/199834.9399MEL34.051$38.8814.17%
    11/14/199714.965JNJ78.923$86.139.13%
    4/13/19988.337CPB54.179$31.06-42.67%

    Trade Date # Shares Ticker Cost Value LT $ Val Ch
    9/8/199722.9859INTC$1,049.37$2,920.65$1,871.27
    11/5/199834.9399MEL$1,189.74$1,358.29$168.54
    11/14/199714.965JNJ$1,181.08$1,288.86$107.79
    4/13/19988.337CPB$451.69$258.97($192.72)
      Cash: $0.01  
      Total: $5,826.77  


    Key
    • S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

    Note
    Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.