WallStreetBeerMoney.com

"Do Your Own Due Diligence, But By God, Don't Drink Away Your Equity!"

dave@wallstreetbeermoney.com

HOME ABOUT WSBM

HOW TO READ A BALANCE SHEET

Who Has The Strongest Dividends: PepsiCo Or Dr. Pepper Snapple?

February 22, 2014

There are a lot of things that one must consider prior to buying stock in a publicly-traded company. Some of these things include the strength of a company's business model, geographic diversification, financial condition, valuation, and earnings growth.

Another important concern is the dividend that the company in question pays out. Strength and sustainability of the dividend are very important for dividend growth investors. In fact, did you know that 42% of the total return of the S&P 500 over the last 80+ years came from dividends? This is why dividends are so important for any investment portfolio.

Today, let's dig into the consumer goods sector and check out the dividends from PepsiCo and Dr. Pepper Snapple. As most everyone knows, these two companies are big players in the non-alcoholic beverage industry. PepsiCo also has a huge presence in the snack foods industry. We will look into the dividend history of each company, its historical dividend growth rates, whether or not each company's dividend is supported by cash flows, and whether the companies can sustain their dividend growth rates in the future.

Dividend Yield

When talking about a company's dividend, the first thing that normally comes to mind is the dividend yield, which is the percentage of your capital that you receive in return over the next 12 months, as long as the dividend amount is not changed. Here are the dividend yields from both PepsiCo and Dr. Pepper Snapple.

PepsiCo 3.3%
Dr. Pepper Snapple 3.2%

 

Table 1: Dividend Yields of PepsiCo and Dr. Pepper Snapple

The dividend yields of both of these companies are about the same. These dividend yields reflect the dividend increases that were announced by each company earlier this month. The dividend yield of PepsiCo is at its highest level in 2 years. Dr. Pepper Snapple has consistently traded at its current dividend yield over the last couple of years. For this reason, a lot of investors would say that PepsiCo is a better value based on historical dividend yield.

Dividend Growth

The dividend yield is just one of many factors that need to be considered when it comes to the strength of a company's dividend. A company's stock can have a high dividend yield due to an unsustainable dividend payout ratio, or poor fundamentals that have brought down the stock price. These items could then lead to a dividend cut, which will reduce your yield on cost.

Dividend growth should also be considered. This is because a company that increases its dividend payout every year maintains the purchasing power of the income streams that are received by its investors. If dividend growth rates can't keep up with inflation, then investors are really losing money when they consider the loss in purchasing power. Dividend increases also signal a strong outlook by management and underscores their commitment to shareholders. Many companies regard their dividends as a sacred cow. Over time, dividend growth can supercharge an investor's yield on cost. Consider Warren Buffett, who started buying Coca-Cola back in the '80s. Now, he receives a yield on cost of 40%, and growing every year as long as Coca-Cola keeps increasing their payout. Sounds like a pretty good deal, no?

Let's see how the dividends of PepsiCo and Dr. Pepper Snapple have grown over the last 5 years. The numbers in the table represent the average dividend growth rate over the last five years.

PepsiCo 7.9%
Dr. Pepper Snapple 16.5%

 

Table 2: Five-Year Dividend Growth Rates of PepsiCo and Dr. Pepper Snapple

Both of these companies have shown outstanding dividend growth rates over the last five years, easily outpacing the erosive effects of inflation. However, Dr. Pepper Snapple has the highest 5-year dividend growth rate, more than double that of PepsiCo. This company has increased its dividend every year since its spinoff, back in 2008. These numbers are skewed a bit, as the company increased its dividend by 34% between 2010 and 2011. The increases, however, have been progressively smaller since then, with the most recent one coming in at 7.9%, actually lower than PepsiCo's recently-announced increase of 15%. Before this recent increase, PepsiCo increased its dividend by between 4% and 7% over the last five years. PepsiCo has now increased its dividend every year for the last 42 years!

These strong dividend histories could not have happened without each company's exceptionally strong business models and brand strength. For right now, while Dr. Pepper Snapple has the higher 5-year dividend growth rate, PepsiCo's 42-year history of consecutive annual dividend increases just can't be beat. With that history, along with PepsiCo's most recent increase beating out that of Dr. Pepper Snapple, I give PepsiCo the edge here.

Dividend Payout Ratio

High dividend yields and strong growth rates are all well and good, but we need to make sure that the company in question is making enough money to keep the dividends going. This is where the dividend payout ratio comes in. The payout ratio is the percentage of the company's profits that get returned to shareholders in the form of dividends. You usually like to see this ratio at 60% or below, as that will insure that the dividends will continue to get paid, even if the company experiences a downturn over a short period. Dividend payout ratios that approach or exceed 100% may signal future dividend freezes or cuts, which are not good at all for investors.

The table below shows the dividend payout ratios for PepsiCo and Dr. Pepper Snapple, both on a trailing twelve month and a four-year average basis. The earnings that I used in these calculations are referred to as core earnings, which remove one-time items that don't have an impact on the company's operations.

Company TTM 4-Year Average
PepsiCo 50% 58%
Dr. Pepper Snapple 46% 42%

 

Table 3: Dividend Payout Ratios of PepsiCo and Dr. Pepper Snapple

From the looks of Table 3, the dividend payments of both PepsiCo and Dr. Pepper Snapple are in excellent shape.  None of them appear to be in any danger of getting cut. The current payout ratio of Dr. Pepper Snapple is slightly higher than its four-year average. PepsiCo's payout ratio is significantly lower than its four-year average. PepsiCo's low payout ratio may have led the company to increase its dividend by a whopping 15%. It will be interesting to see what the payout ratio of PepsiCo looks like after this higher dividend kicks in.

While both companies are looking very good in this category, Dr. Pepper Snapple has the lower payout ratio of the two.

How About That Free Cash Flow?

A lot of folks would end their analysis after calculating the dividend payout ratio. However, we need to keep in mind that that figure is based on dividend payout as a percentage of earnings, not actual cash that comes into the business over a certain period of time. Earnings often contain items like depreciation, asset impairments, actuarial gains on pension plans, and other non-cash items that can distort the picture as to how healthy a company's dividend really is. For this reason, I like to calculate the free cash flow payout ratio, which shows us what percentage of cash that comes in over a 12-month period gets distributed to shareholders. This paints a more accurate picture when it comes to the dividend safety of the company in question.

Table 4 shows how much of both PepsiCo's and Dr. Pepper Snapple's free cash flow was paid out in dividends. Note that free cash flow is calculated as operating cash flow, subtracted by capital expenditures. Trailing 12-month and four-year average figures are shown.

Company TTM 4-Year Average
PepsiCo 50% 55%
Dr. Pepper Snapple 44% 51%

 

Table 4: Free Cash Flow Payout Ratios of Coca-Cola and Dr. Pepper Snapple

Here, we see that the dividends that are currently coming from each company are more than well-supported. With that said, Dr. Pepper Snapple has the edge here as well, with less than half of its free cash flow being paid out as dividends. This should leave plenty of room for future dividend increases, provided that the company can continue its current free cash flow generation.

PepsiCo also looks good here, but I expect the free cash flow payout ratio to rise with the big dividend increase.

When it comes to the free cash flow payout ratio, Dr. Pepper Snapple is the winner here.

Any Ways To Predict Dividends Going Forward?

A lot of folks would end their analysis here, especially after looking at the free cash flow payout ratios. However, these figures are all based on what happened in the past. We need to find some clues as to whether the company can continue paying steadily increasing dividends in the future.

Interest Coverage Ratio

The interest coverage ratio illustrates the size of the company's pre-tax profits relative to the company's interest payments. Generally speaking, the more debt a company has, the more interest it has to pay, and the less that the company has left over to pay out dividends. The interest coverage ratio is calculated by dividing the company's earnings before interest and taxes (EBIT) by the company's interest payments made over the same period of time. Low interest coverage ratios (usually below 2) generally show that the company is having a hard time just trying to make its interest payments. That may signal dividend cuts or eliminations in the future. For this reason, we like to see high interest coverage ratios.

Table 5 shows the interest coverage ratios of PepsiCo and Dr. Pepper Snapple over the last 12 months.

PepsiCo 11.9
Dr. Pepper Snapple 8.5

 

Table 5: Interest Coverage Ratios of PepsiCo and Dr. Pepper Snapple

Table 5 shows us that while Dr. Pepper was able to cover its interest obligations almost 9 times last year, PepsiCo has it beat, with an interest coverage ratio of almost 12. So, while both companies are excellent in this regard, PepsiCo wins out here.

Net Debt To Equity Ratio

The amount of debt that a company has can ultimately influence the future direction of the company's dividend. Companies that have more debt typically pay more in interest. It should also be noted that at some point, the company's debt will need to be repaid. While many companies are working around this by refinancing the debt at low interest rates, this option might not be as attractive when interest rates head back up. When the company finally does extinguish its debt, it may have an adverse effect on whether it can continue paying dividends.

The net debt to equity ratio can offer us some clues as to how much of a problem debt will be when it comes to paying out dividends. It is calculated by subtracting the company's cash position from the company's short and long-term debts, and then dividing that by the company's equity position. The lower this ratio, the better it is for not only the company in question, but for us as investors. Ratios under one are typically considered to be good.

PepsiCo 0.82
Dr. Pepper Snapple 1.06

 

Table 6: Net Debt To Equity Ratios of PepsiCo and Dr. Pepper Snapple

 

Table 6 shows that while both of these companies look decent here, PepsiCo wins this comparison.

 

Forecasted Earnings Per Share Growth

Dividend growth can be driven by a couple of different factors. One of these factors is the expansion of the company's payout ratio, where the company decides to pay out a higher percentage of its earnings or free cash flow to shareholders as dividends. However, you can only expand the payout ratio so much. Eventually, you must have free cash flow growth in order to pay steadily increasing dividends. And, we all know that free cash flow growth comes from earnings growth. To get a good idea as to the prospects of a company's future dividend payments, it may behoove us to look at analyst projections for future earnings per share growth over the next couple of years. Table 7 shows the forecasted earnings per share growth rates for PepsiCo and Dr. Pepper Snapple over the next couple of years. These numbers come from the analysts at S&P Capital IQ.

Company 2014 2015
PepsiCo 8% 8%
Dr. Pepper Snapple 10% 6%

 

Table 7: Forecasted Earnings Per Share Growth for PepsiCo and Dr. Pepper Snapple

Both PepsiCo and Dr. Pepper Snapple are expected to post solid earnings per share growth over the next couple of years. Dr. Pepper Snapple has better estimates for this year, but PepsiCo has better estimates for next year.

Conclusion

Today, we have looked at a number of different factors in order to determine the strength and sustainability of the dividends of PepsiCo and Dr. Pepper Snapple. These factors include the dividend yield, historical dividend growth rates, payout ratios, interest coverage ratios, net debt to equity ratios, and analyst projections for future earnings per share growth. After giving careful consideration to all of these factors, we can conclude that none of the dividends being paid by either of these companies appear to be in any danger as of this writing.

When it comes to which company has the best dividends going forward, it's very evenly matched. Both companies currently have roughly the same dividend yield. While Dr. Pepper Snapple has a higher 5-year dividend growth rate, PepsiCo has it beat in the consistency department with 42 straight years of dividend increases. Dr. Pepper Snapple has lower payout ratios, both on an earnings and a free cash flow basis, leaving plenty of room for future dividend increases. However, PepsiCo has Dr. Pepper Snapple beat when it comes to a higher interest coverage ratio and a lower net debt to equity ratio.

At this point, I would say that both companies are too evenly matched to say that one's dividends are better than those of the other. If you have to choose one or the other for investing, you may want to consider that PepsiCo has a huge global footprint with a diversified business model that includes snack foods in addition to beverages, while Dr. Pepper Snapple has been retiring about 5% of its stock every year in spite of its operations being confined to North America.

I think that it would be wise to own both.

HOME ABOUT WSBM

HOW TO READ A BALANCE SHEET

 

WallStreetBeerMoney.com

"Do Your Own Due Diligence, But By God, Don't Drink Away Your Equity!"

dave@wallstreetbeermoney.com