Should Income Investors Buy This Unstoppable Dividend King?

Rising inflation has increased the risk that the US will soon enter a recession. According to a Bloomberg survey of economists, the average likelihood of a US recession over the next 12 months has risen from 30% in June to 47.5% now.

The growth-focused Nasdaq Composite is down 27% so far. But investors flock to sectors with more predictable demand, such as consumer staples. That’s why dividend king PepsiCo (NASDAQ:PEP) is down less than 1% so far this year.

But is the food and beverage company a buy for income investors at the moment? Let’s examine PepsiCo’s fundamentals and valuations to find the 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 earnings per share (EPS) both topped the analyst consensus during the quarter.

PepsiCo reported net revenue of $20.2 billion in the second quarter, a 5.2% increase from the year-ago period. This was marginally 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 consecutive quarter?

Its portfolio of well-known brands like Tostitos Chips, Tropicana Juice and Muscle Milk are consumed more than 1 billion times a day by consumers around the world. And since PepsiCo is more geared towards domestic consumption, its brands hold up better in times of recession. That’s because when budgets are tight, consumers try to save cash, and so don’t frequent places like restaurants and theme parks.

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PepsiCo’s popular portfolio of brands allowed the price hike to pass along to consumers in the second quarter. And because of the wide moat provided by those brands, consumers weren’t phased out by these high prices. In fact, PepsiCo’s “convenience foods” volume increased 3%, while its beverage volume grew 6% during the quarter.

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

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

As a result of the brand strength of PepsiCo’s product portfolio, analysts expect similar earnings growth in the future. It is estimated that the company’s core EPS will grow at 7.9% annually over the next five years.

Image Source: Getty Images.

Beginning of a streak of dividend growth

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

Dividend payout ratio is set to be manageable at 67.8% in FY 2022. This should allow dividends to grow as rapidly as income for the foreseeable future, which is why I believe 7% annual dividend growth should be ideal. Given that the stock’s 2.7% dividend yield is nearly twice the S&P 500 index’s 1.6%, it makes PepsiCo an attractive pick for both current and future earnings.

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Valuation Isn’t A Deal, But It’s Fair

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

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Kodi Castor has a position at PepsiCo Inc. The Motley Fool does not have a position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed here are the views and opinions of the author and do not necessarily represent those of Nasdaq, Inc.

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