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PepsiCo: Defense in a Bottle

This heavy-weight company looks like a strong contender in a defensive portfolio, say some analysts.

With the market unable to mount an offense lately, now may be a good time to lighten up on riskier stocks and start playing defense with some blue chips -- at least, that's the view of analysts at UBS. They argue that although large-company stocks have mostly been warming the bench in recent years, it's time for portfolio coaches to send them in. Their favorite blue chip starter offering consistent earnings growth and a strong balance sheet: PepsiCo.

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UBS analyst Caroline Levy is impressed that the soft-drink and snack-food giant has consistently posted double-digit earnings growth over the past few years, even in the face of rising costs for oil (petroleum that is, not the stuff they fry their Fritos in) and other essentials. The company generates strong free cash flow, which can be used for dividends and share buybacks. Plus, PepsiCo is making its operations more efficient, which should reduce costs down the road. Levy also notes that PepsiCo's stock (symbol PEP) historically has been unaffected by interest rates or the pace of U.S. economic growth, which is a good thing considering how rising inflation and interest rates are spooking the stock market.

Perhaps PepsiCo is immune to economic crosscurrents because its products are about as essential to American life as football and, well, Pepsi Cola. Shopping carts without Mountain Dew, Tropicana and Cheetos? Unimaginable, even if gas busts $10 a gallon and interest rates blow past 10%. PepsiCo has even grown adept at layering a healthy sheen on classic junk foods by lowering the fat content. It's also begun offering more low-calorie beverages and emphasizing its more-nutritious offerings through its Smart Spot program.

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When it comes to non-fizzy drinks, PepsiCo has jumped ahead of rival Coke. Noncarbonated drinks now account for a third of PepsiCo's domestic beverage sales. Levy sees plenty of room for growth, especially in Gatorade, which, she notes, dominates the sports-drink market, with an 80% share.

PepsiCo has also grown adept at peddling these staples of the American diet to our friends overseas. More than a third of its revenues came from abroad last year, according to Morningstar. And Levy says that international profits should continue to grow better than 15% annually. Consumers in China and India offer big potential for increased sales, she says. In fact, she sees PepsiCo as a good way to invest in the growth of emerging nations, particularly Mexico, China, Russia, and Brazil, without being exposed to their boom-and-bust financial markets.

Levy says the stock, recently $60, looks attractively priced at 18 times her 2007 profit estimate of $3.40 per share. She upgraded the stock to "buy" on Friday and raised her 12-month target price from $64 to $74. The stock yields 2%.

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