Should Income Investors Buy This Unstoppable Dividend King?

view original post

Mounting inflation has raised the risk that the U.S. will soon enter into a recession. The median probability of a U.S. recession in the next 12 months has shot up from 30% in June to 47.5% now, according to a recent Bloomberg survey of economists. 

The growth-focused Nasdaq Composite has dipped 27% year to date. But investors have flocked to sectors with more-predictable demand, like consumer staples. This is largely why the Dividend King PepsiCo (PEP 0.07%) is down less than 1% so far this year. 

But is the food and beverage company a buy for income investors at this time? Let’s examine PepsiCo’s fundamentals and valuation to get an answer to this question.

PepsiCo rarely fails to impress Wall Street

PepsiCo didn’t disappoint earlier this month when it shared its financial results for the second quarter, ended June 11. Net revenue and adjusted diluted earnings per share (EPS) both topped the analyst consensus during the quarter.

PepsiCo reported $20.2 billion in net revenue in the second quarter, a 5.2% growth rate over the year-ago period. This was moderately higher than the $19.5 billion that analysts were expecting for the quarter. How did the megacap company surpass the analyst net revenue consensus for the 10th quarter in a row?

Its portfolio of well-known brands such as Tostitos chips, Tropicana juice, and Muscle Milk are consumed more than 1 billion times in a day by consumers the world over. And since PepsiCo is more geared toward home consumption, its brands tend to hold up better in recessions. That’s because when budgets are tight, consumers try to conserve cash, and therefore don’t frequent venues like restaurants and theme parks as often.

PepsiCo’s popular portfolio of brands allowed it to pass price hikes along to consumers in the second quarter. And due to the wide moat provided by those brands, consumers weren’t phased by these higher prices. In fact, PepsiCo’s “convenient foods” volume edged 3% higher while its beverages volume increased 6% during the quarter.

The company posted $1.86 in core EPS for the second quarter, which was an 8.1% year-over-year growth rate. PepsiCo had no difficulty in beating the analyst core EPS estimate of $1.73 in the second quarter. This was the 10th consecutive quarter that the company matched or exceeded the analyst core EPS prediction.

A higher net revenue base and improved operating efficiency allowed PepsiCo’s adjusted net margin to climb 30 basis points from the year-ago period to 12.8% for the second quarter. This more than offset the 0.1% increase in the company’s weighted-average outstanding share count to 1.4 billion.

As a result of the brand power of PepsiCo’s product portfolio, analysts are expecting similar earnings growth in the future. It’s anticipated that the company’s core EPS will grow at 7.9% annually through the next five years. 

Image source: Getty Images.

Just the start of the dividend growth streak

PepsiCo’s 50 consecutive years of dividend growth gives it one of the longest-running track records among stocks of similar stature. Yet it looks like the company is just getting started with handing out passive income raises to its shareholders.

The dividend payout ratio is set to be manageable at 67.8% in fiscal year 2022. This should allow for the dividend to grow nearly as fast as earnings for the foreseeable future, which is why I believe 7% annual dividend growth should be the norm. Considering that the stock’s 2.7% dividend yield is nearly double the S&P 500 index’s 1.6%, this makes PepsiCo an attractive pick for both current and future income. 

The valuation isn’t a bargain, but it’s fair

PepsiCo’s price-to-earnings (P/E) ratio of 25.9 might be moderately higher than its 10-year median P/E of 23.3. But the company’s fundamentals are arguably stronger than they have been in years. That’s because the forecast of 7.9% annual earnings growth would be a significant acceleration over the 5.3% annual earnings growth rate for the past five years. This is why the stock appears to be a buy at the current $172 share price.

Kody Kester has positions in PepsiCo Inc. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.