PepsiCo stock (NASDAQ:PEP) has underperformed notably over the past year, failing to keep pace with the broader market, which has surged to new highs over the same period. The international beverage and snack giant continues to grow its revenues and earnings at a decent pace, especially given the outsized expansion it has experienced in recent years. Thus, I see the recent weakness in the stock price as an attractive chance for investors to buy this quality stock at a compelling valuation. Hence, I am bullish on PEP stock.
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Is PepsiCo’s Growth Slowing Down?
One possible reason for PepsiCo’s stock lagging over the past year is what appears to be a slowdown in its growth. In its most recent Q1 results, PepsiCo’s revenues grew by just 2.3%, a rate lower than current inflation levels.
Yet, some context is required to appreciate that this growth figure is still impressive. I am referring to the fact that PepsiCo continues to record growth on top of the substantial gains achieved in previous years. Specifically, PepsiCo’s revenues grew by 12.9% and 8.7% in FY2022 and FY2023, notably higher than its 10-year compound annual growth rate (CAGR) of 3.3%, which includes these two years.
This substantial growth in prior years was driven by aggressive price hikes, with management leveraging a highly inflationary environment and resilient consumer spending to significantly boost prices, even at the expense of volumes sold. Sustaining high-single to low-double-digit revenue increases over the medium to long term would be unrealistic. Nevertheless, PepsiCo’s ability to squeeze significant price hikes in the span of just two years and still achieve more growth entering FY2024 is a notable achievement.
Note that in Q1, PepsiCo maintained the same strategy but not as intensely. The average prices of its snacks and beverages increased again, this time by 5%. This came at the cost of a 2% decline in volumes sold. Along with a 0.5% favorable foreign exchange impact, these numbers derived the 2.3% top-line growth previously mentioned.
Clearly, as long as the company can achieve a net positive impact on the top line through pricing, it is a sensible approach. This aligns with basic economic principles and price elasticity mechanics. In fact, given that higher prices can propel margins higher, leading to even more significant earnings growth, you can see management’s rationale.
Earnings Growth Justifies Price Increases
As I just mentioned, it makes total sense for PepsiCo to pursue higher pricing when it has a net positive impact, as besides higher sales, price increases usually leave room for margin expansion. For instance, the 8.7% increase in sales last year, as highlighted earlier, led to a much larger adjusted earnings growth of about 14%. The same was true in PepsiCo’s Q1, with adjusted earnings rising by about 7%, notably higher than the 2.3% increase in sales.
Strong Full-Year Outlook Exposes Attractive Valuation
Following robust adjusted earnings growth in Q1, management affirmed its outlook, forecasting strong momentum for the rest of the year. It now expects adjusted earnings per share (EPS) to grow by 8% for the full year. This anticipated increase highlights that shares are trading at an attractive valuation after their recent dip. Even when considering Wall Street’s more conservative EPS growth estimate of 7%, PepsiCo is currently trading at 20.6 times this year’s expected earnings.
The current valuation presents a compelling opportunity because PepsiCo is a high-quality company that rarely trades at a discount. Historically, investors have been willing to pay multiples averaging between 23 and 25 times earnings, thanks to its outstanding reputation and a 52-year track record of uninterrupted dividend growth. Consequently, I believe that PepsiCo’s investment case also offers a wide margin of safety at its current levels.
Is PepsiCo Stock a Buy, According to Analysts?
Regarding Wall Street’s view on the stock, PepsiCo has a Moderate Buy consensus rating based on eight Buys and six Holds assigned in the past three months. At $187.09, the average PEP stock price target suggests 12.2% upside potential.
If you’re unsure which analyst you should follow if you want to buy and sell PEP stock, the most profitable analyst covering the stock (on a one-year timeframe) is Dara Mohsenian from Morgan Stanley (NYSE:MS), with an average return of 12% per rating and a 91% success rate. Click on the image below to learn more.
Conclusion
PepsiCo presents a compelling opportunity for investors despite its recent underperformance. While its latest quarterly report raised concerns about a potential growth slowdown, when viewed in the right context, its strength becomes evident.
The company understands how to leverage pricing to boost sales and earnings growth, even if it occasionally impacts volume. In the meantime, its present valuation hovers below historical averages, which, when combined with a strong full-year outlook, implies both a wide margin of safety and compelling upside potential.
