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3 Reasons to Buy PepsiCo Inc.

By Andrés Cardenal – Mar 7, 2016 at 12:27PM

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Competitive strength, solid financial performance, and impressive capital returns make the soft drink and snack food powerhouse a stock worth considering.

Source: PepsiCo

PepsiCo (PEP 0.83%) is not precisely the most innovative and cutting-edge investment idea around. However, the company has crushed the S&P 500 on a total return basis over the past 25 years, and it still looks remarkably strong going forward. 

PEP Total Return Price Chart

Data by YCharts

High-quality companies with solid competitive strengths, reliable financial performance, and consistent dividend growth can be particularly profitable investments, and PepsiCo fits that description quite well.

Delicious brand power
Competitive strength is arguably the most important factor to consider when making long-term investment decisions. While PepsiCo comes behind Coca-Cola in soft drinks, the company owns a remarkably valuable portfolio of drink and snack brands, including not only traditional products but also high-growth offerings targeted toward health-conscious consumers.

Coca-Cola is the undisputed leader in traditional sodas due to the tremendous strength of its flagship Coca-Cola brand, and PepsiCo's flagship soft drink Pepsi has long battled for the second place against Diet Coke. Nevertheless, while sodas are still big business for both companies, sales volumes for these products are stagnant or even declining in developed markets, as consumers increasingly seek out healthier choices. 

PepsiCo has been betting on this trend for a long time. The company has reclassified its portfolio into three different product categories: "Fun for you" which includes traditional sodas and snacks; "Better for you", typically low-calorie versions of its products; and "Good for you" which offers healthier products with brands such as Gatorade, Quaker, Tropicana, Aquafina, and Naked Juice, among others.

PepsiCo owns 22 different brands that generate more than $1 billion each in annual global sales. The snacks business produced 53% of total revenue in 2015, and healthier beverages such as water, sports drinks, and juice account for a growing share of drink revenue. All in all, traditional sodas currently account for only 25% of the top line.

Sweet financial performance
PepsiCo is a market leader in a stable and mature industry, so it's not easy for the company to find significant growth opportunities. Most global currencies have also been depreciating against the U.S. dollar, especially in emerging markets, and this is hurting sales and profits. However, company has still managed to deliver rock-solid financial performance.

Organic revenue grew 5% during 2015, while gross margin expanded by 140 basis points over 2014, and the company delivered a 10% increase in constant currency earnings per share, comfortably above management's initial target of 7%. The business produces massive quantities of cash -- free cash flow amounted to more than 12% of revenue last year -- and the company distributed $9 billion to investors via dividends and buybacks in 2015. 

The company is aggressively focused on cutting costs via productivity savings. PepsiCo achieved $1 billion in cost savings in 2015, and management believes it's well on track to reaching its productivity target of cutting annual expenses by $5 billion from 2015 to 2019.

Sparkling dividend growth
The company has a truly amazing track record of dividend growth, having increased its dividends in each and every year for the last 44, with a compound annual dividend growth rate of 10% over the last decade. The dividend payout ratio is quite safe, in the neighborhood of 60% of the company's core earnings, and management is deeply committed to consistent dividend growth.

This means that PepsiCo has not only the capability but also the willingness to continue rewarding investors with increasing dividends over the long-term. In the words of CEO Indra Nooyi, "Continuity of dividends and growth in annual dividend per share are a point of great pride for PepsiCo, and we view them as a vitally important element to the total shareholder return equation."

Management is expecting to return $4 billion in cash to investors via dividends and an additional $3 billion in stock buybacks during 2016. The dividend yield stands at nearly 3% at current prices, and the total cash return -- dividends plus buybacks over market capitalization -- is approaching 5%. Not bad at all coming from such a remarkably strong dividend powerhouse. 

Andrés Cardenal has no position in any stocks mentioned. The Motley Fool owns shares of and recommends PepsiCo. The Motley Fool recommends 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.

Stocks Mentioned

PepsiCo Stock Quote
$185.90 (0.83%) $1.54
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$4,076.57 (-0.09%) $-3.54
Coca-Cola Stock Quote
$63.79 (0.28%) $0.18

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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