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Better Buy: PepsiCo vs. Altria

Leo Sun, The Motley Fool

PepsiCo (NASDAQ: PEP) and Altria (NYSE: MO) are both classic dividend plays for conservative income investors. PepsiCo has raised its dividend annually for more than four decades, and Altria has raised its dividend every year since it spun off its overseas business as Philip Morris International in 2008.

However, both companies face long-term headwinds. PepsiCo faces sluggish demand for its carbonated drinks and packaged foods, while lower smoking rates are causing Altria's cigarette shipments to slide. Is one of these consumer staple stocks a better investment than the other?

A bottle of cola being poured into a glass.

Image source: Getty Images.

PepsiCo's strengths and weaknesses

PepsiCo's North American business is split into three groups: Frito-Lay North America, Quaker Foods North America, and PepsiCo Beverages North America. These three units generated 64% of PepsiCo's revenue and 79% of its operating profit in the first half of 2019. Revenue at all three units rose year over year during that period, but operating profits at Quaker Foods and PepsiCo Beverages declined.

The rest of PepsiCo's business comes from three overseas divisions: Latin America; Europe and sub-Saharan Africa (ESSA); and Asia, Middle East, and Africa (AMEA). Revenues in Latin America and ESSA rose during the first half but declined slightly in the AMEA region. Operating profits rose in Latin America but fell in the other two regions.

PepsiCo's organic sales (adjusted for "impacts of acquisitions, divestitures and other structural changes and foreign exchange translation") rose 4.8% in the first half of the year, but its core (adjusted) EPS dipped 2%. For the full year, PepsiCo expects its organic sales to rise 4% but its core EPS to dip 3% (or 1% on a constant-currency basis).

PepsiCo attributes that earnings decline to tougher comparisons to 2018, when asset sales, refranchising efforts, and a lower tax rate boosted its bottom line. It also expects to make bigger investments in improving its core business this year, but that could be challenging -- soda consumption in the U.S. is currently near a three-decade low, according to Beverage Digest, and other packaged-foods giants are struggling as shoppers flock toward healthier products.

A woman rejects an offered pack of cigarettes.

Image source: Getty Images.

Altria's strengths and weaknesses

Altria is still the biggest tobacco maker in the U.S., but its market is rapidly shrinking. Only 14% of U.S. adults were still smokers in 2017, according to the CDC, compared to 42% in 1965. Altria is addressing that slowdown with three core strategies: raising cigarette prices to offset lower shipments; diversifying into adjacent markets like snuff, alcohol, and e-cigarettes; and deploying aggressive cost-cutting measures and buybacks to boost its earnings.

Those strategies helped Altria tread water for years, but they've become less effective in recent quarters. Altria's total cigarette volumes fell 14% annually during the first quarter, causing its total revenue (excluding excise taxes) to tumble 6%. Cost-cutting measures and aggressive buybacks failed to boost its adjusted earnings, which fell 5%.

Altria's noncigarette businesses also barely moved the needle, with cigar shipments inching up 1% and smokeless (snuff) shipments dipping 2%. Its wine shipments rose 8%, but the unit's revenue accounted for less than 3% of Altria's top line. Altria's "all other" unit (which includes e-cigarettes) still generates an insignificant percentage of its sales. That figure could rise as it taps into its new 35% stake in e-cigarette leader Juul Labs, but that plan faces fierce resistance from the FDA.

Altria didn't provide revenue guidance for the full year, but it expects total domestic cigarette industry volumes to fall 4% to 5%. However, Altria still expects its adjusted earnings to rise 4% to 7% as it implements more price hikes, cost-cutting strategies, and buybacks.

Which stock is a better buy?

PepsiCo offers a forward yield of 2.9%, which is much lower than Altria's 6.5%. PepsiCo's forward price-to-earnings ratio of 22 also makes it seem pricier than Altria, which trades at just 11 times forward earnings estimates.

Altria's higher yield and lower valuation might make it look more attractive than PepsiCo. However, Altria is cheap because its core market is shrinking, its $13 billion investment in Juul smacks of desperation, and its methods of boosting its EPS face diminishing returns.

PepsiCo's business is better diversified than Altria's, but it still faces tough challenges in the soda and snack food markets. PepsiCo's valuation is also high relative to its earnings growth -- which likely occurred because investors flocked to the stock as a defensive play amid global uncertainties. 

It's hard to recommend either stock at these levels, especially when other stable dividend stocks are trading at lower valuations. Altria needs to offer investors a clear long-term roadmap for its plans beyond tobacco, and PepsiCo's stock needs to cool off before it can be considered a worthy buy. But once PepsiCo's stock pulls back, I'd pick it over Altria -- since it has a better diversified business, its core business doesn't face a terminal decline, and it isn't buffeted by regulatory headwinds like the tobacco giant.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.