Companies and Brands
In the COVID-19 Economy, Now Is Time to Buy Stock in PepsiCo and Coca-Cola
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The economy went from a strong recovery and an 11-year raging bull market to a bear market and an instant recession in just 30 days or so. Now every business, even most “defensive” business sectors, are in trouble as earnings forecasts are nearly impossible to make and companies are not even willing to stand behind any prior guidance. Companies like Coca-Cola Co. (NYSE: KO) and PepsiCo Inc. (NYSE: PEP) are supposed to be about as defensive as they come.
While the world turned upside down, the defensive stocks were largely crushed as the economic pinch is punishing virtually everyone. Coca-Cola lost an unthinkable 40% of its value in just a month, while the more diversified PepsiCo lost 31% of its value from peak to trough.
Two different analyst reports now suggest that the COVID-19 pandemic damage has been enough. Argus upgraded Coca-Cola to Buy from Hold with a $54 target price, Credit Suisse upgraded PepsiCo to Outperform from Neutral with a $144 target price.
While both upgrades are impressive and are calling for a much better performance ahead, investors should consider that neither price target is back above the recent highs from earlier this year. Investors also should keep in mind that no single analyst report should ever be the sole basis for making any investment decision.
While Argus raised Coca-Cola with that $54 target price, the firm recommends that investors dollar-average into existing long-term positions in the highest-quality stocks such as this one. In short, it’s not a pile all-in call. The same recommendation is there for initiating new positions at discounted prices, while still maintaining awareness that there are risks of future volatility in individual positions.
As Argus looks at history, “periods of severe stock-market turbulence have proven to be good times for investors with a longer-term time horizon to focus on the highest-quality and financially strongest names.” This is despite a March call when the company warned that it does not expect to meet 2020 financial expectations due to the COVID-19 disruption. The Argus report from Chris Graja comes with the expectation that Coca-Cola’s earnings and the share price will rebound.
Graja’s report further added:
A very recent indicator of financial strength is that the company was able to issue $5 billion of new bonds and CEO James Quincey told CNBC, on March 24, that the offering was “massively oversubscribed,” suggesting investor confidence in the company’s prospects out to bond maturities in 2040 and 2050. Management has recognized that it needs to diversify revenue away from sugary soda and we expect it to make progress toward this goal. The company eliminated more than 600 “zombie,” or unproductive, products in 2019 and worked to reposition the business through changes in core products, pack sizes and serving sizes, as well as through deals like the recent acquisition of coffee company Costa. The company’s innovation has also improved. The primary reason Coca-Cola was not on our Buy list at the beginning of the year is because our analysis suggested that the company’s investment merits were reflected in the share price.
The report pointed out that even companies like Procter & Gamble, the leader in the giant consumer products category, have shown that they are not immune to disruption from COVID-19. Graja also took into consideration that Coca-Cola is likely to see large sales declines of beverages as venues such as restaurants, amusement parks, sporting events and schools are now offline. Grocery store volumes likely will not offer enough of a near-term offset, even if those sales rise dramatically.
Credit Suisse’s Kaumil Gajrawala and Robert Moskow made the call on PepsiCo, raising the target price to $144 from $138. That report calls PepsiCo a high-quality asset trading at a discount with drivers in the near, medium and long terms, and it noted that the price-to-earnings multiple has contracted five turns just as business trends are set to accelerate. The firm also sees a cultural shift and the most aggressive capital deployments in years supplementing its Outperform rating. The team even pointed out an incremental $12 billion investment in less than two years that covers advertising, capital spending and mergers and acquisitions to bring benefits for the coming years.
In the medium term, Credit Suisse sees signs that North American beverages (roughly one-third of sales and the weakest division) are poised to improve. The top Pepsi and Gatorade brands are showing improvements at the same time that innovation is helping to gain share with the aid of Bubly and Zero. The firm even sees Mountain Dew as finally unleashed with Rockstar energy drinks, now that the deal is resolved. The report further added:
We now think North American beverages topline can go to +3% to +4% growth on improved industry dynamics, portfolio evolution, and increased spend. More importantly, margin opportunity is substantial. We estimate ~$0.50 (+10%) EPS upside if PBNA can return margins to 2011 levels (14-15% from today’s 10%)… Near-term, COVID-19 highlights defensive nature of PepsiCo – strong positions in water, sports drinks, juice brands and beneficiary from snack pantry loading. Direct store delivery distribution a competitive advantage and likely to strengthen relationship with retailers.
A broad sell-off and profit-taking session has both stocks weak, but the drop in the Dow Jones industrials of 3.3% and the S&P 500’s drop of 3% on the day are looking worse than both companies.
Coca-Cola stock traded down about 2.25% at $43.40 a share on Friday, with a $185 billion market cap. Its 52-week trading range is $36.27 to $60.13, and its dividend at this lower share price is almost 3.8%. Refinitiv’s consensus analyst target price is $57.34.
PepsiCo stock was down 0.3% at $119.90, in a 52-week range of $101.42 to $147.20. Its dividend yield is almost 3.2%. The market cap is $167 billion, and the consensus target price is $141.59.
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