MorningWord 2/11/15: Soda Pop – $PEP

by Dan February 11, 2015 9:30 am • Commentary

Pepsi (PEP) just reported Q4 results and 2015 guidance, and the stock briefly made a new all time high in the pre-market. This is all a bit confounding to me. Given the lack of growth, continued FX and commodity headwinds. Why are investors willing to pay north of 21x for a company growing earnings and sales at best at low single digits (at best).  But you know the drill, these companies BUY BUY BUY their own shares and create the illusion of earnings growth. Which brings me to THE highlight from the company’s earnings release:

Company expects to return approximately $8.5 to $9 billion to shareholders through dividends and share repurchases in 2015

I have not been shy of my dislike of low growth expensive consumer staples like PEP which are trading near 10 year highs in terms of multiples as investors look for yield (PEP div yield 2.65%) and the embedded buyback return. This party ends once rates start to go higher for two reasons. The first is that the div and cash flow yield will be less attractive, and second, much of this cash return bonanza has been fueled by low rates.  PEP plans to return 6% of its current market cap to shareholders, despite the stock being at all time highs, as they increase their debt load to 22% of their market cap.

While I have a negative fundamental view on owning stock’s like PEP, I wasn’t willing to step in front of what almost seemed like an inevitable reaction (although I did put a bearish trade on in KO following its results yesterday – here), and frankly PEP looked poised for a technical breakout one way or the other, from Chart of the Day post:

The 6 month chart of PEP below shows the big ol triangle pattern the stock is making that is likely to resolve itself one way or the other, and soon:

PEP 6 month chart from Bloomberg

If I were purely a vol trader, and agnostic on direction, and given KO’s move today and some of the moves in other staples, this set up has the potential for out-sized movement.  If you agree and think the move is cheap, then those with a directional bias should like the directional set up with defined risk all the better. No strong conviction here, and not dying to make a sort of binary play, so I’ll wait and digest the news tomorrow.

For now the path of least resistance remains up (discussed this last week here). But expensive consumer staple stocks could be the first casualties of a higher rate environment that is comes from an improving global economy as investors may rotate out of defensive sectors and into more economically sensitive sectors like industrials and banks which has been recent laggards.  As for PEP, I think we will leave this one alone for a while, we have placed our chips on the table with our view on KO.