In the second quarter, I recommended PepsiCo (PEP) and Zimmer Holdings (ZMH). Both companies recently reported better-than-expected earnings for that quarter, but their stocks followed very different trajectories. PepsiCo shares rallied to a recent high of $72.76, while Zimmer's share price declined a bit to $58.70 based on a modest revenue shortfall and some market-share loss in the U.S. I continue to like both names, with a particular emphasis on Zimmer in light of the stock's recent price decline.
PepsiCo is a leading consumer packaged goods manufacturer with iconic brands such as Pepsi, Frito-Lay and Quaker Oats. During the recent quarter, PepsiCo reported better-than-expected earnings of $1.12 per share vs. $1.09 consensus. Revenues were in-line driven by solid 1% unit volume gains and 4% price/mix benefits. Management affirmed the guidance for the year, even with the tough macro concerns across Europe. My high opinion is due to the company's stable revenue and earnings profile, topped-off by a high-dividend yield.
Management is making renewed efforts to revitalize the core franchises and earnings growth profile of PepsiCo. After struggling for the past few quarters, part of the improvement might have been driven by an outside push from stakeholder Relational Investors. I expect management's commitment to improvement to continue.
The stock has a 3% dividend yield, a strong "AA" investment-grade credit rating, and a 52% payout ratio. For the past decade, PepsiCo has consistently grown revenues by 10% per year, earnings by 10.5% per year, and dividends by 13%. The company has raised the dividend every year for the past 10 years. I expect PepsiCo to continue growing its dividend in line with its long-term growth rate of 8% to 10% per year based on acquisitions and continued emerging-market penetration. PepsiCo should still provide solid upside capital appreciation, be reasonably protective in a choppy market and pay investors a solid dividend while they wait.
Zimmer Holdings is a leading orthopedic manufacturer with high market shares in knee, hip, fracture management and dental implants. Zimmer reported better-than-expected earnings of $1.34 per share vs. $1.31 consensus. Revenues were a bit light at $1.125 billion, $10 million shy of estimates, however, management reaffirmed guidance for the year on an expected pickup in the second half of 2012 and on share repurchases. While sales growth has been more difficult to come by during the weak global economic environment, the company has done a very good job of growing earnings and meeting or exceeding earnings expectations by controlling expenses and engaging in a stock buyback. I expect the same discipline and commitment to grow earnings to continue.
The other area of disappointment was modest market share lose in the U.S. for knee and hip products (the company's market share was stable internationally). While I never like to see short-term share slippage, I am very confident in the company's product lines and believe that, over time, it will be able to maintain market share, which is at a very healthy 20% to 25% range.
Earlier this year the company initiated its first dividend, which stands at 1.2%. I expect the dividend to show nice growth. The company has an "A+" investment-grade credit rating with a balance sheet that is close to net debt free. For the past decade, Zimmer has consistently grown revenues by 14% per year and earnings by 15% per year. Although Zimmer's growth rate has slowed in recent years due to the macro industry headwinds of reduced procedure growth and downward pressure on prices, I expect Zimmer to report 3% to 5% revenue growth per year and 8% to 10% earnings growth due to continued modest industry growth, further emerging market penetration and aggressive share repurchase programs.
As discussed in April, shareholders might get lucky with a takeover of the company, as it has very attractive attributes that should appeal to a larger healthcare player.
Take advantage of the recent stock decline, which was driven by the modest revenue miss, concerns over share loss in the U.S. knee and hip markets and a conservative top-line outlook. ZMH's market valuation is very attractive relative to the company's current and long-term earnings power and cash flow.