Play for the Pepsi Pop

 | Feb 10, 2012 | 12:00 PM EST  | Comments
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This commentary originally appeared at 9 a.m. EST on Real Money Pro -- Click here to learn about this dynamic market information service for active traders.

Pepsi (PEP) is more than just soda. It owns Gatorade, Tropicana, Mountain Dew, Quaker Oats and Frito Lay in addition to its flagship cola products. Annual worldwide sales in 2011 -- announced just yesterday -- were the highest ever at $66.5 billion, and core earnings were also an all-time best at $4.40 per share.

You might have expected those record results to take PEP shares above previous peaks. Instead, Pepsi closed Thursday at $64.27, well below the 2011 high of $71.89 and the 2008 apex of $79.80.

Just a glance at the chart shows that PEP isn't far from its lows since November 2009. Its P/E of 14.6x last year's earnings is more than a 30% discount to the 10-year median multiple. You'd have to go back to the 1980s to see this low a valuation (unless you caught the exact panic lows of March 2009 or October 2011).

PEP chart -- BigCharts

Similarly, Pepsi's yield of 3.21% is the highest ever available except for the 2009 nadir. Financial strength is rated A++ by Value Line, which also assigns PEP its top rank for safety.

Management announced cost-cutting moves that will hurt 2012 earnings slightly while setting the stage for better results in the years that follow. CEO Indra Nooyi also disappointed some traders in saying she had no immediate plans to spin off the Frito-Lay division.

What is PEP worth? Morningstar and S&P see fair value as $72 and $70 respectively. Research firm Trefis comes to a similar conclusion of $71.30 based on a sum-of-the-parts analysis (less net debt). If it takes a full year to rebound to $71, you'd have a 10.47% gain in addition to the yield, for a projected total return of about 13.7%.

There really nothing wrong with that rate of return for a conservative, high-predictability investment in a near-zero-interest-rate environment. Is $71 an achievable goal? Sure. PEP topped above that level in three of the past five calendar years.

Options players wanting an even better entry point should consider selling some LEAP puts against a long position in the shares.

PEP trades

In each of the option trades shown above, your worst-case scenario would be acquiring PEP near 28-month lows and with a very attractive yield.

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