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Is PepsiCo, Inc.'s Dividend Sustainable?

By James Sullivan – Jul 21, 2015 at 1:21PM

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Pepsi is well-diversified, both geographically and with its many different brands. But is Pepsi still a good long-term dividend investment considering the declining popularity of soda pop?

PepsiCo (PEP 1.96%) is often thought of as merely the silver medalist in the global soda battle with Coca-Cola. This relationship is so well-known that it's commonly used to qualify the relationship between other companies. Someone might ask, "Who is the Pepsi to Apple's Coke in the smartphone business?"

What might be less-known about Pepsi is that it also controls a broad portfolio of well-known packaged-food brands, including Quaker Oats, Doritos, and Stacy's pita chips. Soda sales are down across the board, but Pepsi's diversification -- with regards to geography and a multitude of different brands -- should allow it to continue paying and raising its dividend for many years to come. PepsiCo currently pays $2.81 per share per year in a dividend, which at the current stock price is a yield of roughly 3%.

Dividends are an important part of investments
For most investors, Pepsi's dividend is a fundamental component of their investment thesis. The company's days of explosive net income growth are likely long gone, but moderate growth, a dividend that currently yields right around 3%, and well-executed share repurchases can provide more-than-satisfactory returns with limited risk of permanent loss of capital. The company this year plans to return a total of $8.5 to $9 billion to shareholders through a combination of dividends of approximately $4 billion and share repurchases of $4.5 to $5 billion. 

To figure out if the payout is sustainable and, ideally for investors, able to be raised in the future, we can look to recent top- and bottom-line numbers, analyze what makes the business special, and look at how much wiggle room the company has to maintain and raise its dividend without much net income growth.

Revenue dropping; net income flat
In the most recent quarter, Pepsi saw revenues decline 6% from the same period in 2014. This is not a great sign for the long-term success of the business, but there is a silver lining: Net income during the same period was flat and the dividend payout higher.

Management was successful in reducing cost of sales and SG&A expenses enough to ensure that even with a drop in sales, net income didn't drop as well. Return on equity and return on assets, which are two of the key measures of managerial efficiency, remain very robust in the low 30s and 8.86, respectively, on a TTM basis. This compares favorably to Coke's numbers, which are in the low 20s and 7.72.

Diversification offers some protection
The biggest hit to revenues and operating profit by far came from PepsiCo Europe, where revenues were down 24%, and operating profit was down 26% year over year, or YOY. PepsiCo America Beverages grew revenues by 1%, and operating profit by 4% YOY.

By not focusing entirely on one geographic region for sales and profits, Pepsi has time to fix problems in these areas without it sinking the entire operation. PepsiCo Europe as a publicly traded company would be drawing the intense ire of the market. PepsiCo, as a whole, continues to chug along.

Frito-Lay North America was the second-largest division by revenue, up 2% YOY in the most recent quarter. It's the largest contributor to operating profit for the company, as it grew this number 7% YOY, and is now responsible for about one-third of the total pie. This snack-food segment is the predominant bulwark against a decline in Pepsi's overall operating income.

Maybe in the future, Europe will pick up and help to carry a weakening Frito-Lay division. This is the beauty of the conglomerate corporate structure that Pepsi has created.

Dividend payout ratio leaves some room to grow
All of this talk about maintaining net income levels in order to pay and raise the dividend would be moot if Pepsi was already paying out to investors more than it takes in in free cash flow, or FCF. Its TTM dividend payout ratio is 61%, which means it has leeway to continue to pay and raise its dividend for years to come.

If revenues and net income improve, as management expects, investors can look forward to some modest capital appreciation along with rising dividend payments. For investors looking for a defensive company that will be pumping out dividends for years to come, Pepsi deserves a spot on your watch list.

James Sullivan owns shares of Apple and PepsiCo. The Motley Fool recommends Apple, Coca-Cola, and PepsiCo. The Motley Fool owns shares of Apple and PepsiCo and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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