PepsiCo Joins the Dividend Kings

On Feb. 10, PepsiCo Inc. (NASDAQ:PEP) announced its intention to increase its dividend by 7% starting with the June payment. This dividend increase is important as the company will have achieved 50 consecutive years of dividend growth, placing it amongst the storied ranks of the Dividend Kings.

There are less than 40 names with the required growth streak to earn the title of Dividend Kings, putting PepsiCo in rarefied air for dividend paying companies. Let's take a look at PepsiCos business model and dividend growth history to see how it has achieved this feat and why it will likely continue to raise its distributions for years to come.

Company background and recent results

Tracing its roots back to the late 1800s, PepsiCo has become a juggernaut in the food and beverage industry. While best known for its beverages, PepsiCo actually earns half of its revenue from food and snacks. The company has also taken steps to meet changing consumer tastes, with nearly half of revenue coming from its Better For You product line. PepsiCo has a market capitalization of $233 billion and has an enviable portfolio of food and beverages, with more than 20 brands bringing in around $1 billion in annual revenue.

PepsiCo released fourth-quarter and full year 2021 earnings results on Feb. 10. The companys revenue grew more than 12% to $25.3 billion year-over-year for the quarter. Adjusted earnings per share improved to $1.53 per share, up from $1.47 in the prior-year quarter.

For the year, revenue increased nearly 13% to $79.5 billion, with adjusted earnings per share totaling $6.26 versus $5.52 in 2020.

Looking back at a longer time frame, revenue and adjusted earnings per share have five-year compound annual growth rates (CAGRs) of 5.8% and 4.6%, respectively. A slightly lower share count has aided earnings growth during this period of time. Most of the increase in earnings per share, however, has come simply from higher sales as the net profit margin is down marginally over this period of time.

Stretching back a decade, revenue is higher by 5% annually, while adjusted earnings per share has compounded at a CAGR of 5.3%.

PepsiCo has shown very consistent growth rates over the medium- and long-term, a very important characteristic for a company that raises its dividend every year.

Dividend history and recession performance

This level of consistent growth has allowed PepsiCo to increase its dividend for what will be five decades come June.

Given the length of the growth streak, PepsiCo has proven successful at raising its dividend even during recessionary environments. The companys business model has proven very resistant to economic downturns, as seen by adjusted earnings per share results before, during and after the last recession:

  • 2006 adjusted earnings per share: $3.00

  • 2007 adjusted earnings per share: $3.34 (11% increase)

  • 2008 adjusted earnings per share: $3.21 (3.9% decrease)

  • 2009 adjusted earnings per share: $3.77 (17.4% increase)

  • 2010 adjusted earnings per share: $3.91 (3.7% increase)

  • 2011 adjusted earnings per share: $3.98 (1.8% increase)

PepsiCo experienced a small earnings decline in 2008, but quickly returned to growth the following year and posted a new high. At the same time, the companys dividend grew 22.4% from 2007 to 2009.

PepsiCo successfully accomplished this feat partially because it operates in a sector that tends to withstand the headwinds of recessions.

This performance also speaks to the power of the companys brands in its portfolio. Dating back to 2005, PepsiCo never had back-to-back years of declining adjusted earnings per share until 2019 and 2020. It took a worldwide slowdown related to Covid-19 to make that happen, and even then the decline was just $0.01 per share from 2019 to 2020.

As with the Great Recession, PepsiCo quickly returned to growth, registering a 13.4% improvement in adjusted earnings per share for 2021. The company also raised its dividend 5.1% in 2020, further proof that shareholders can expect a dividend increase even under adverse economic conditions.

PepsiCos dividend yield is 2.6% presently, just below the stocks 10-year average yield of 2.9%, but considerably higher than the average yield of 1.4% for the S&P 500 Index.

Dividend growth and payout ratios

PepsiCos consistent growth over the medium- and long-term has fueled consistent dividend raises as well. The companys dividend has CAGRs of 7.2% and 7.8% over the past five- and 10-year periods of time, respectively. PepsiCo can provide such dividend raises because its business performance keeps its payout ratios in good shape.

The company distributed $4.20 of dividends per share in 2021, resulting in a payout ratio of 67% for the year. This is an elevated payout ratio, but in-line with the average payout ratio of 66% since 2017. Over the last decade, the average payout ratio is 62%, so this past years ratio wasnt too far off what are PepsiCos traditional levels.

For a company in a more defensive sector, such as PepsiCo, a payout ratio above 50% isnt unhealthy in my opinion. The companys earnings per share have generally moved higher over the long-term, such that the payout ratio isnt at a point where I am concerned about a dividend cut. If anything, lower dividend growth could be in the offering, but the most recent increase is close to its average.

Free cash flow paints a similar picture of dividend safety. PepsiCo distributed $5.8 billion of dividends in 2021 while producing free cash flow of close to $7 billion for a free cash flow payout ratio of 69%. For the 2018 to 2020 time period, PepsiCos average free cash flow payout ratio was 88%. So, while elevated again, last years ratio was much better than the three previous years. This will be something to watch going forward, but the improvement in the ratio is a positive sign to me.

Looking at the earnings and free cash flow payout ratios, PepsiCos dividend likely remains safe.

The impact of debt on dividend security

The last item I look for in evaluating a companys ability to continue to grow its dividend is debt obligations and how that may weigh on future increases.

PepsiCo had interest expense of $1.86 billion last year. Total debt was $40.8 billion as of the end of 2021, giving PepsiCo a weighted average interest rate of 4.6%.

The chart below shows how high the blended interest rate would have to increase before dividends would no longer be covered by free cash flow.

PepsiCo Joins the Dividend Kings
PepsiCo Joins the Dividend Kings

Source: Authors calculations

Examining the chart above, PepsiCos average interest rate would need to expand to 7.5% before dividend distributions would be no longer covered by free cash flow. Some investors might prefer a wider margin of safety, such as the one that Caterpillar Inc. (NYSE:CAT) provides. Personally, PepsiCos stable business model is enough for me to expect that debt obligations will not hinder future dividend payments.

Final thoughts

PepsiCo will join the exclusive Dividend King index with its June payment. The companys long-term success is due to the demand for its well-known brands. Results last year show that consumers continue to find PepsiCos offerings attractive. The company has withstood the worst of multiple recessions and performed very well during the pandemic. The payout ratios are in the high 60% range, but PepsiCo is one of the more stable companies in the market.

For these reasons, PepsiCo is likely to continue to raise its dividend for years to come while offering a market-beating dividend yield. PepsiCo remains one of my favorite names to own in the consumer staple sector.

This article first appeared on GuruFocus.