Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company or by reviewing the 5 Most Undervalued Companies for the Defensive Investor – December 2014. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how Pepsico Inc. (PEP) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): PepsiCo, Inc. (PepsiCo) is a global food and beverage company. Through the Company’s bottlers, contract manufacturers and other partners, the Company makes, markets, sells and distributes a range of foods and beverages in more than 200 countries and territories. PepsiCo is organized into four business units: PepsiCo Americas Foods (PAF), which includes Frito-Lay North America (FLNA), Quaker Foods North America (QFNA) and all of its Latin American food and snack businesses (LAF); PepsiCo Americas Beverages (PAB), which includes all of its North American and Latin American beverage businesses; PepsiCo Europe, which includes all beverage, food and snack businesses in Europe and South Africa, and PepsiCo Asia, Middle East and Africa (AMEA), which includes all beverage, food and snack businesses in AMEA, excluding South Africa. In February 2014, PepsiCo Inc acquired a 75.53% interest in Lebedyansky JSC.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – PASS
- Moderate PEmg ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$61.59|
|Value Based on 0% Growth||$36.10|
|Market Implied Growth Rate||7.35%|
|Net Current Asset Value (NCAV)||-$20.20|
Balance Sheet – September 2014
Earnings Per Share
Earnings Per Share – ModernGraham
Pepsico Inc. is not suitable for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned with the low current ratio, and the high PEmg and PB ratios. The Enterprising Investor is concerned with the level of debt relative to the current assets. As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities. As for a valuation, the company appears to be overvalued after growing its EPSmg (normalized earnings) from $3.63 in 2010 to an estimated $4.25 for 2014. This level of growth does not support the market’s implied estimate of 7.35% growth, leading the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well below the price.
Be sure to check out previous ModernGraham valuations of Pepsico Inc. (PEP) for greater perspective!
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on Pepsico Inc. (PEP)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
Disclaimer: The author did not hold a position in Pepsico Inc. (PEP) at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.