Drip
Portfolio Report
Tuesday, January 27, 1998
by Randy Befumo
([email protected])
ALEXANDRIA, VA (Jan. 27, 1998) -- Today we look at the four finalists for the food investment side by side to help decide which one we are going to commit capital to by starting a Dividend Reinvestment Plan.
Let's line 'em up by a few categories at a time and take a look.
Ticker Price Yield Campbell Soup CPB ~$55 1.5% PepsiCo PEP ~$37 1.4% Philip Morris MO ~$45 3.6% Quaker Oats OAT ~$521/2 2.2%Although this one may be the most simple of anything we look at, it in some ways is the most telling. Dividend yield is a very important component of total return. In a world that routinely ignores yield, it is a place where investors interested in value tend to gravitate. That nice quarterly payment can be used automatically to purchases shares at no commission, the whole original purpose of a dividend reinvestment plan. With the average stock on the S&P 500 yielding 1.6%, Philip Morris and Quaker Oats present the most compelling dividend yields. Even in a worst-case scenario with the tobacco settlement (meaning no increase in cigarette prices), Philip Morris could still afford its dividend payout. With a price increase, it can keep up its ambitious share repurchase program. Also, should legislation settle the tobacco issue once and for all, a separation of the tobacco and food operations is conceivable. (AOL users please maximize the window for the next table.)
Enterprise EV/Sales EV/Operating
Value(EV) Earnings
Campbell Soup $26,586 M 3.3 17.2
PepsiCo $58,249 M 2.7* 15.7*
Philip Morris $120,786 M 1.7 9.4
Quaker Oats $7,940 M 1.5* 13.0*
* -- last quarter annualized instead of last 12 monthsThese are the main valuation parameters that we will use in the Drip Portfolio for this selection. The reason we are looking at operating earnings instead of net earnings (as in the P/E ratio) is because of pending spin-offs and recent divestitures. For some of these companies, units that were part of the results a few months ago are no longer included. For others, the shifts in debt have changed net earnings because of changing interest payments. As a result, looking at the multiple to operating earnings is just a little bit easier. The only thing for you to keep in mind is that price-to-operating earnings ratios are routinely 30% to 40% below the equivalent price-to-earnings ratio.
Of the companies in our sample, the most expensive based on operating earnings and sales is Campbell Soup. This is where we would argue that PepsiCo has what could be considered the most room for reasonable improvement in margins among the companies in this the sample (although one could argue Quaker has some room as well). The only risk is that looking at the valuation you can see where a good portion of this has been priced into the stock, as it currently trades on par with Campbell Soup -- one of the best managed companies in the last two years. The cheapest stock in the group is Philip Morris, whose valuation has always been held back because of perceived tobacco liability. Should that tobacco liability disappear this year (as I think it might), given the company's ability to raise prices, on a net basis its valuation should increase much faster than earnings growth might decrease due to a settlement.
For Philip Morris, the question remains "How much will tobacco usage be affected by higher prices that will result from a settlement?" The tobacco companies have already slowed orders per their own filings as well as on information released by Dimon (NYSE: DMN), one of the two publicly-traded tobacco leaf producers. Price hikes have not had a major affect on unit volume before, but the magnitude of the price hikes being contemplated to pay for the roughly $20 billion per year portion of the settlement that will belong to Philip Morris is huge. Although there will be cost savings with the extinction of all advertising spending, this will certainly not even come close to paying the bill. All in all, though, the risk of lower unit volume on cigarettes and any potential decrease in the growth rate of Philip Morris earnings seems to have been efficiently priced into the stock.
Quaker Oats, for its part, trades at what appears to be a low level, although I must hasten to remind readers that we may have annualized a seasonally strong quarter. Even if this is the case, Quaker would certainly not be expensive even if the multiple to sales or earnings were increased 20% to 40%. The company trades at a slight discount to Campbell Soup, which is the second-most expensive company in the survey. We shall soon see, however, that it is the operating margins and earnings growth that allow Campbell Soup to warrant what may be a justifiable premium.
Thus, from the stand point of valuation, we can see where Philip Morris has discounted a future negative event, PepsiCo has discounted a future positive event, Campbell Soup has discounted the continuation of above average growth and shareholder returns and Quaker Oats seems to discount nothing in particular, as investors obviously anticipate improved results but have not moved the share price above what might be considered a reasonable range. Based on valuation alone, Philip Morris would be the strongest selection, although would carry the most risk. PepsiCo would be the weakest selection, as it has already assumed quite a bit of improvement in the share price. Campbell Soup and Quaker are more moderate cases, and neither is as dirt cheap as Philip Morris. Thus, based on valuation we would label Philip Morris "low", Quaker "moderate", and Campbell Soup and PepsiCo "moderate to high".
Tomorrow, we look at operation efficiency, shareholder returns and share buybacks. As we wrap up our look at the four food companies, please share your thoughts on them in the Drip Companies message board. We'll highlight some of your thoughts here for readers, as we did with the email that we received during the pharmaceutical industry analysis. Your thoughts mean a great amount in the learning process for everyone. You listed your top four food companies about three weeks ago, and now it's time to state your favorite and give reasons why.
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