Introduction
Financial analysis involves appraisal of the performance of a business, project to establish suitability and financial performance. This paper aims to examine the financial performance of Pepsi-Co Inc. for the last three years based on ROE, dividends growth, and capital constraints.
Return on Equity using the Dupont system
Dupont analysis is an extended evaluation of the return on equity formula employed in assessing the various drivers of return on Equity (Gibson, 2020) . Companies use Dupont analysis in a bid to try and figure out ways to increase the return on Equity and ensure investors get value for the investment made in the company. Dupont analysis comprises of three ratios. Profit margin is used to assess a company's capability to generate positive returns in the form of profits. Equity multiplier analyses the levels of debt utilized in the company, while asset turnover determines the efficiency of management in the utilization of the company's assets to generate sales revenue.
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DuPont framework is given by; Profit margin * Equity multiplier * Asset turnover.
DuPont analysis for Pepsi-Co: Figures in $ million:
Profit margin; Net income / Net sales
2019: = 7353 / 67161 = 0.11
2018: = 12559/ 64661 = 0.19
2017: = 4908 / 63525 = 0.077
Equity Multiplier: Average total assets / average total equity
2019: = 78098 / 14735 = 5.30
2018: = 78726 / 12791.50 = 6.15
2017: = 76647 / 11090 = 6.91
Average total assets;
2019: (78547 + 77648) / 2 = 78097.50
2018: (79804+77648) / 2 = 78726
2017: (73490+79804) / 2 = 76647
Average total equity;
2019: (14602 + 14868) / 2 = 14735
2018: (10981 + 14602) / 2 = 12791.50
2017: (11199+10981) / 2 = 11090
Asset turnover: Net sales / Average total assets =
2019: 67161/ 78098 = 0.86
2018: 64661 / 78726 = 0.82
2017: 63525 / 76647 = 0.83
DuPont 2019 = 0.11 * 5.30 *0.86 = 0.501
DuPont 2018 = 0.19*6.15*0.82 = 0.958
DuPont 2017 = 0.077*6.91*0.83 = 0.442
Source : ("Annual Reports and Proxy Information", 2020)
The profit margin moves up in 2018 from 7.7 per cent to 19 per cent before falling again to 11 per cent in 2019 while the asset turnover decline first from 0.83 to 0.82 in 2018, further rising to 0.86 2019. Equity multiplier ratio has been dropping for the three years from a high of 6.91 to 5.30 in 2019. The trend in these ratios exhibit wave-like form with the drop in 2019 for the ROE is the rise in operating costs, additional debt financing that made profit margin and equity multiplier to drop. Asset turnover increased as a result of rise in sales revenue and drop in average assets as the company disposed some items of PPE in the year.
The main competitor for PepsiCo Inc. is Coca-cola. Coca-Cola's Dupont analysis;
| Profit Margin | Equity Multiplier | Asset Multiplier | |
|
2019 |
0.24 |
4.22 |
0.44 |
|
2018 |
0.19 |
4.50 |
0.40 |
|
2017 |
0.04 |
4.15 |
0.41 |
Coca-Cola DuPont for three years;
2019: 0.24*4.22*0.44 = 0.446
2018: 0.19*4.50*0.40 = 0.342
2017: 0.04*4.15*0.41 = 0.068
The trend on profit margin is rising for Coca-Cola, unlike for Pepsi-Co, which dropped in 2019. Coca-Cola's equity multiplier has risen for the three years, unlike Pepsi-co, which has dropped, but both companies exhibit a similar trend on asset turnover, dropped, and then rose again in 2019. The major driver of ROE for both companies is the equity multiplier. Pepsi-Co has higher ROE for all three years.
The industry average ROE for 2019 is 33.18 percent. Both Pepsi-Co and Coca-Cola performed above the industry average, which is an indication the companies are significant players in the industry.
Constant growth stock valuation of Pepsi-Co and how it compares with its market price.
The constant growth model is used to determine the intrinsic value of a stock on the assumption that future dividends grow at a constant rate each year. The approach assumes that current stock price is a function of rate of dividend growth, dividends and the investors required rate of return. The intrinsic stock price is determined as follows;
P 0 = = ,
| Yearly Dividend | Yearly Increase Rate |
| 2019 4 ∙ $0.955 = $3.79 | ($3.79 - $3.59)/$3.59 = 0.05571 |
| 2018: 4 ∙ $0.928 = $3.59 | ($3.59 - $3.16)/$3.16= 0.13608 |
| 2017: 4 ∙ $0.805 = $3.16 | ($3.16 - $2.96)/$2.96 = 0.06756 |
| 2016: 4 ∙ $0.753 = $2.96 | ($2.96- $2.76)/$2.76 = 0.07246 |
| 2015: 4 ∙ $0.703 = $2.76 | ($2.76 - $2.53)/$2.53 = 0.09090 |
| 2014: 4 ∙ $0.655 = $2.53 |
Average yearly dividend growth rate =
(0.09090 + 0.07246 + 0.06756 + 0.13608 + 0.05571) / 5
= 0.42271 /5
= 0.084542
Assume the cost of capital is 12.5%
Therefore;
D1 = (0.955 + 0.955 + 0.955 + 0.955) = $2.865
P0 = 2.865 / (0.125 – 0.084542) = $ 70.81
The market price of Pepsi-Co as at close of business July,17,2020 was $ 134.66. The intrinsic value of the share is lower than the market price representing an overvaluation. The intrinsic value reflects the correct valuation of stock while forces of demand and supply determine the market price, and it is not the true value of the stock. The market forces of demand and supply have acted on the price leading to its rise over and price the correct valuation. Investor demand has exerted pressure on the share price as more investors are eager to partake in the company’s future.
Capital Constraints
To be competitive in the Beverages industry, Pepsi-CO needs to consider hard capital rationing and soft capital rationing. The hard-capital rationing may occur when Pepsi-Vo has problems raising funds, either through debt or Equity. Soft capital rationing, on the other hand, is a capital constraint that arises due to internal policies created by the company. For example, Pepsi-Co is likely to experience this type of limitation as it has a high requirement of return on capital to accept a project.
Pepsi-Co is known to undertake several projects, and some of them go for a long time without fully being completed. This, as a result, leads to a drop in the company ROI. As a result of the decline in return on investments, Pepsi-Co management is typically prompted to impose caps on the number of new projects through increased capital cost for the original plans. By starting fewer new projects would allow Pepsi-Co to acquire more resources and time to complete the projects that are underway and not yet completed.
Projects are very critical for any company. Investing in new projects ensures that the company remains productive, competitive, and progresses in terms of technology and all other growth assets. Pepsi-Co may also evaluate and solve this capital constraint by rationing tis capital to minimize the amount of money paid to the investors in terms of dividends. While the reduction in profits may hurt the share price, it has the desired overall effect. This way, the company can get funds to relieve its debts.
In this regard, Pepsi-Co should ration its existing capital and efficiently invest in projects, giving it the chance to increase its bottom line, raise its dividend yield, or raise its actual dividend per share. Pepsi-Co should use capital budgeting techniques that involve the discounting of cash flows in determining the viability of a project. The net present value approach is used to determine which projects to invest in that will add value to the company. The company should also adopt project evaluation techniques such as the profitability index and accounting rate of return ( Financial Management: Theory and Practise , 2015) . These techniques help in highlighting risk profiles of projects and check the viability of projects so that the company can only invest in the most viable projects.
Conclusion
Pepsi-Co has had a mixed financial performance for the last three years as ROE ratio shows. The rate rose from 0.44 in 2017 to 0.96 in 2018 but declined rapidly from 2019 to 0.50. The drop in ROE came amidst increasing sales revenue and rising operating costs that impacted the ratio negatively. Pepsi-Co dividend payments are projected to grow at 8 percent in the next five years, and the stock has high demand at the stock exchange due to high dividends and capital gains. Pepsi-Co has to exercise capital rationing to invest in projects with the highest returns to guarantee value for the investors
References
Annual Reports and Proxy Information . PepsiCo, Inc. Official Website. (2020). Retrieved 19 July 2020, from https://www.pepsico.com/investors/financial-information/annual-reports-and-proxy-information
Gibson, C. (2020). Financial Reporting & Analysis (13th ed., pp. Chapter 5: 199 - 208). Cengage Learning.
Thompson, South-Western. (2015). Financial Management: Theory and Practise (12th ed., pp. Chapter 11;377 - 400).
