- United States
Calculating The Fair Value Of PepsiCo, Inc. (NASDAQ:PEP)
- Using the 2 Stage Free Cash Flow to Equity, PepsiCo fair value estimate is US$175
- PepsiCo's US$175 share price indicates it is trading at similar levels as its fair value estimate
- Analyst price target for PEP is US$186, which is 6.2% above our fair value estimate
Does the March share price for PepsiCo, Inc. (NASDAQ:PEP) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for PepsiCo
Crunching The Numbers
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$8.83b||US$10.5b||US$10.9b||US$11.3b||US$12.2b||US$12.6b||US$13.1b||US$13.5b||US$13.9b||US$14.2b|
|Growth Rate Estimate Source||Analyst x6||Analyst x7||Analyst x4||Analyst x1||Analyst x1||Est @ 4.06%||Est @ 3.46%||Est @ 3.04%||Est @ 2.75%||Est @ 2.55%|
|Present Value ($, Millions) Discounted @ 6.8%||US$8.3k||US$9.2k||US$8.9k||US$8.7k||US$8.7k||US$8.5k||US$8.2k||US$8.0k||US$7.7k||US$7.3k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$83b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$14b× (1 + 2.1%) ÷ (6.8%– 2.1%) = US$305b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$305b÷ ( 1 + 6.8%)10= US$158b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$241b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$175, the company appears about fair value at a 0.02% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at PepsiCo as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 6.8%, which is based on a levered beta of 0.800. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for PepsiCo
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings and cashflows.
- Dividend is low compared to the top 25% of dividend payers in the Beverage market.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Dividends are not covered by cash flow.
- Annual earnings are forecast to grow slower than the American market.
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For PepsiCo, there are three fundamental aspects you should explore:
- Risks: Case in point, we've spotted 3 warning signs for PepsiCo you should be aware of.
- Future Earnings: How does PEP's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
Valuation is complex, but we're helping make it simple.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
PepsiCo, Inc. manufactures, markets, distributes, and sells various beverages and convenient foods worldwide.
Solid track record average dividend payer.