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Katz: Two Names Continue to Impress

In the second quarter, I recommended PepsiCo (PEP - Get Report) 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.

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