PEP is unattractive due to unsustainable dividend growth driven by high free cash flow payout ratios (99.5%) and weak future cash flow guidance.

Now, we come to Pepsi stock, a stock that I'm starting to wonder if people are tired of me talking about. Why? Well, I get tons of requests to cover Pepsi stock. I keep seeing online how it's an incredible opportunity because the starting yield is one of the highest it's been really in the last 5 to even 10 years.

On top of this, the valuation multiple is the lowest it's been in 10 years. However, I've been talking bad about Pepsi for really the last 3 to four years. In fact, I wrote an article on Seeking Alpha over a year ago titled Buy or Beware.

The warning signs are there. And Pepsi has not done well over the last year or over the last 5 years.

And the reason I've been able to look past the fact that the starting yield was significantly higher than on average. The PE multiple on the surface level looked much more attractive than it has been historically was simply because I understood they were facing some serious capital allocation issues.

And I pointed this out before, but it's worth pointing out again. Look at Pepsi's dividend metrics. Again, what you'll see on the surface level, nice starting yield, 4.26%. 26% dividend growth in the range of 6 to 7% over the last 5 and 10 years with a history of growing dividends.

I mean, it's a dividend king stock. 50 consecutive years of dividend increases.

And I pointed this out before, but it's worth pointing out again. Look at Pepsi's dividend metrics. Again, what you'll see on the surface level, nice starting yield, 4.26%. 26% dividend growth in the range of 6 to 7% over the last 5 and 10 years with a history of growing dividends.

I mean, it's a dividend king stock. 50 consecutive years of dividend increases. But the story starts to look different when we look at the free cash flow payout ratio over time.

So, what are the issues here? Well, we know a company can only sustainably pay out as much in dividends as it generates in free cash flow. A decade ago, the free cash payout ratio was 51%.

Now, we're sitting at 99.5%. So when we look at these dividend growth rates, yes, it looks good on the surface level, but the reality is that this was what's known as unsustainable dividend growth.

Anytime a stock is growing dividends at a rate higher than free cash flow is growing, that's unsustainable dividend growth. So that's an issue. The dividend can't go any higher without them going over 100% free cash payout ratio, which ultimately means they're weakening the balance sheet.

But the story starts to look different when we look at the free cash flow payout ratio over time. So, what are the issues here? Well, we know a company can only sustainably pay out as much in dividends as it generates in free cash flow.

A decade ago, the free cash payout ratio was 51%. Now, we're sitting at 99.5%. So when we look at these dividend growth rates, yes, it looks good on the surface level, but the reality is that this was what's known as unsustainable dividend growth.

Anytime a stock is growing dividends at a rate higher than free cash flow is growing, that's unsustainable dividend growth. So that's an issue. The dividend can't go any higher without them going over 100% free cash payout ratio, which ultimately means they're weakening the balance sheet.

But the issue doesn't just stop there. Take a look at their recent earnings report. Scroll down. Let's look for guidance. You can see fiscal 2026 guidance and outlook. Here's what we need to pay attention to.

Organic revenue is projected to only increase between 2 and 4%. So low levels of revenue growth. We'll keep that in mind. We'll come back and look at that here in a moment. But we can also see a free cash flow conversion ratio of at least 80%.

At least 80%. Now remember, free cash conversion ratio is basically telling us what percentage of earnings is getting translated into free cash flow. And if we jump over to the free cash analysis sheet and look at this for Pepsi, historically speaking, scroll all the way over.

Here's their free cash flow conversion numbers. Last year, it was 93%.

So, what are they telling us? Well, they're telling us revenue is going to grow at roughly 2 to 4%. So, roughly in line with inflation, and the free cash flow conversion ratio will likely be lower than it was last year, at least 80%.

So, what does that mean? Well, more than likely what that means is we could see free cash flow be even lower in 2026 than it was in 2025, which naturally means the free cash flow payout ratio will be over 100%.

But the issues really don't just stop there. Take a look at this. They're not just paying out dividends, they're buying back stock. So total cash returns to shareholders in 2026 will be approximately 8.9 billion.

7.9 billion of dividends and sherry purchases at 1 billion. So all of a sudden they're already using more than 100% of their free cash flow for dividends and share buybacks. The company's in a capital allocation disaster because they don't have any capital left over to reinvest back into the business.

And during this time, they're also pursuing mergers and acquisitions like Poppy, which certainly do have the potential to be a credit for the business. They could generate a high return on their invested capital.

But again, the reality is anytime a company is doing something like this and they're using all their capital for buybacks and dividends, they are weakening the balance sheet. They're having to take out debt to fund these projects.

And so the risk for Pepsi, even though they're trading at their lowest valuation multiple in the last 10 years, does continue to grow.

So, can the stock turn things around? Yes, it does have the ability to do that. That's certainly always the case. Is the stock attractive from a risk-to-reward perspective? I really don't think that's the case.

The headline dividend metrics look attractive with the yield and dividend growth numbers. But when you start to dive into the capital allocation, there's a lot more concerns.

And even if we look at this stock from a dividend discount model perspective, let's go ahead and zoom out and take a look at Pepsi. Let's look at that dividend discount model. We'll zoom in closely.

And here's what we'll see. If Pepsi grows the dividend at 3%, which would be pretty great considering the current conditions, the stock would be worth $105. If they can achieve 4%, they're trading close to fair value right now, but there's still some downside.

So, you can see why there's concerns for Pepsi right now. They have to grow dividends at roughly 4.25% moving forward to justify their current valuation. That's my concern with Pepsi right now because that's not a given, particularly over the next few years.

So, again, from a risk-reward perspective, I think there's better opportunities.