Peter Santoro, manager of Columbia Management Advisers' Large Cap Core Fund,
recently picked PepsiCo (NYSE: PEP ) as one of two large-cap stocks with very
attractive valuations. In an interview with The Wall Street Transcript , Santoro
suggested that PepsiCo's strong balance sheet and emerging-markets potential
combined with historically low valuation multiples makes its stock more
attractive than ever . While this might be true, I'm going to play devils
advocate for a moment and give you some reasons why you might want to think
twice about owning its stock. 52-Week Low I'll give Santoro kudos for picking
a stock near its 52-week low. That said, there's a number of big-name drink
stocks, both alcoholic and non-alcoholic, also trading near their one-year lows,
so let's not get carried away. It's an industry thing. Besides, PepsiCo's
stock historically has traded in a tight range, so a low one day is a high the
next. In the past five years, it has moved between $43.78 and $79.79. That's a
difference of only $36. Currently, it sits smack dab in the middle of that
range, so it's fair to say it could just as easily head lower than higher. I
guess that's why they pay money managers the big bucks. However, Pepsico's
stock rarely loses more than 20% in any given year, so the likelihood of it
running back down to $44 is minimal. The big risk here is the markets moving
ahead while PepsiCo doesn't. Price to Free Cash Flow Santoro makes reference
to PepsiCo's historically low valuation multiples. One ratio I use to examine
a stock's value is price to free cash flow. This tells me what investors are
willing to pay for a company's free cash flow. Currently, they will pay 21.1
times free cash flow compared to 27.1 back in 2007, when PepsiCo hit its
five-year high. By this measure at least, it certainly appears less expensive.
In 2007, it generated $4.5 billion in free cash from $39.5 billion in revenues.
In the trailing 12 months, it generated $4.8 billion from revenues of $62.4
billion. Essentially, it generated $300 million in additional free cash from $23
billion in revenue. That's not so good. Furthermore, you can buy Dr. Pepper
Snapple Group (NYSE: DPS ) and Boston Beer Co. (NYSE: SAM ) for 7.7 times and
15.5 times FCF, respectively. The reality is PepsiCo might be cheap in relation
to itself, but who out there invests in a bubble? There are other cheaper
options available. Share Repurchases Part of the free cash flow discussion must
include share repurchases. After all, dividends and buybacks are two of the only
ways a company can reward its shareholders. In the past five years, PepsiCo has
repurchased $17 billion in stock at an average price of $66.15 per share. Its
return on investment is -6.8%. Shareholders will argue that these purchases
reduced the share count, thereby increasing earnings per share. That would be
the case if it didn't issue any new shares. However, in both 2006 and 2007,
it issued 31 million shares for stock options. At the end of the day, $17
billion reduced the share count by just 55 million, or 3.3%. On a good note, any
increase in earnings in that time wasn't from share repurchase sleight of
hand. However, I'll bet you any amount of money that if PepsiCo had paid out
the $17 billion in dividends instead of share repurchases, its stock would have
gained more than 22% over 68 months. Bottom Line PepsiCo might have a pretty
balance sheet, but there are plenty of other large caps with good ones, too.
Heck, Apple (NASDAQ: AAPL ) is Santoro's top holding, and the last time I
checked, it had a decent balance sheet. As of this writing, Will Ashworth did
not own a position in any of the stocks named here.
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