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Investment Overview for PepsiCo (NYSE:PEP)
WHAT HAS CHANGED?
Good performance by drinks might mean PepsiCo is remaining intact
Revenues for PepsiCo are roughly split evenly between drinks and snacks, but the latter is growing faster, and is more profitable, which is why the contribution of the foods division to PepsiCo's overall value is more than the beverages division. As a result, the company has been under pressure from activist investors to spin off the ailing beverages division, and allow the foods business to operate as a single separate unit.
Although segregation of the foods and drinks divisions might be in the cards some time later, it seems that PepsiCo is committed to deriving synergies between the two businesses for the current time, and is heading into the future intact, at least for now.
Beverages aren't growing as fast as snacks, but this segment has seen growth recently, not only in developing economies, but also developed markets such as the U.S., and the synergies cannot be ignored. For example, according to PepsiCo, a significant part of growing the snacks business includes penetrating all retail outlets that beverages are already in, because the company's presence in beverage retail outlets is much higher than in snacks. Apart from leveraging PepsiCo's higher beverage reach to grow snacks, too, what the company stands to gain from keeping the two businesses together are synergies.
PepsiCo is finding growth in the U.S. beverage market
Although the U.S. CSD market declined for the tenth consecutive year in 2014, the rate of decline fell last year, on increased customer spending on perishable products, amid an improving economic environment in the country, reflecting that there might be some fight left in the CSD category.
While Americans continue to fall out of love with sugary sodas, PepsiCo has achieved growth in this category through innovation such as the introduction of Mountain Dew Kickstart and DEWshine, and through pricing and packaging wins -- by focusing on sales of smaller packs (which have a higher price-per-unit) and raising retail prices. The company is also looking to solve the falling-diet-soda-sales problem by removing aspartame from Diet Pepsi, and replacing it with sucralose, better known as splenda, which has a slightly better customer perception than aspartame.
Below are key drivers for PepsiCo that present opportunities for upside or downside to the current Trefis price estimate:
Frito-Lay EBITDA Margins
- Frito-Lay North America EBITDA margins: Margins stood at 33.1% and 34.7% in 2010 and 2011, respectively. In 2013 margins fell to almost 33% due to higher marketing spend, and the restructuring process undertaken by the company. In 2014, margins rose to 33.8% on a 3% net revenue growth, as well as lower commodity costs, primarily cooking oil and corn. We expect long-term margins to rise to around 34.6%. However, if PepsiCo's planned productivity savings and restructuring costs do not yield the desired results and the margins fall to 30%, we could see the Trefis price estimate revised downwards by 7%.
PepsiCo is the world's second largest carbonated soft drink manufacturer and the largest packaged foods product manufacturer. Additionally, it owns a number of other businesses - ranging from fruit juices and other non carbonated drinks, to bottled water, and breakfast cereal.
PepsiCo's most important division is its food products division, which consists of Frito-Lay and Quaker Oats.
PepsiCo's beverage division competes with the Coca-Cola Co. in virtually all sub-segments of the beverage market. Both the companies have been operating for more than a century and compete fiercely across the globe - this fierce rivalry is termed as the Cola Wars. Its flagship brand is Pepsi - the second largest selling CSD (carbonated soft drink) globally - which just trails behind Coca-Cola's flagship brand Coke. Apart from Pepsi, both the companies have competing brands - which closely resemble each other - in all market segments.
In early 2010, PepsiCo completed its merger with major bottlers, Pepsi Bottling Group, and PepsiAmericas, to strengthen its bottling and distribution operations and gain from expected synergies.
We believe that Frito-Lay, Quaker Foods, and other food products, constitutes the most important component of PepsiCo's value:
Frito-Lay has a virtual monopoly in some market segments
Frito-Lay enjoys a virtual monopoly in many sub-segments of the packaged foods market, especially in the US where it owns most of the top selling brands -- Cheetos, Doritos, and Tostitos being a few examples. From potato chips and tortilla chips, to wafers, Frito-Lay commands a dominating position in all market segments. Increasingly, it derives a significant portion of its revenues from new, untapped, and unsaturated markets such as China and India, where traditionally, the general population has not been too exposed to the idea of instant snacks.
PepsiCo has been able to withstand negative publicity around the unhealthy nature of its food products
As with soft drinks, there has been an increased focus on the unhealthy nature of instant snacks. Allegedly, these food products promote binge eating and unhealthy eating habits - especially, in young children. However, PepsiCo has been able to face this increased scrutiny reasonably well. Most of the attention is focused on the likes of McDonald's. For example, Frito-Lay has increased its marketing efforts to counter this campaign. It has also managed to introduce a new line of healthier snacks. Furthermore, Frito-Lay has decided to label its products as gluten-free in order to appeal to gluten sensitive consumers. In addition, PepsiCo, along with Germany's Theo Muller, has also launched yogurt and dairy products in the U.S.
Increased focus on negative health impact of soft drinks is likely to curtail consumption
Over the last few years, there has been an increased focus on rising obesity levels in the general population due to unhealthy eating habits. This is especially true in developed economies like the US and Western Europe where a heavy consumption of fast foods and soft drinks has been blamed for rising obesity levels. This has been especially prevalent among children. As a result, a number of organizations and even local government institutions have increased efforts to curtail consumption of these unhealthy foods. For example, a number of schools and educational institutions have even banned the sale of soft drinks on their premises. The soft drink manufacturers have sought to hit back by aggressive marketing and by promoting alternative healthier drinks. We expect the balance in the beverages market to shift gradually towards non-carbonated soft drink consumption.
Emerging economies are likely to drive growth
Unlike in the developed world, soft drink consumption in emerging economies is still low - the market is unsaturated, especially when seen from a per capita consumption point of view. Over the last few years, both PepsiCo and Coca-Cola have stepped up efforts to increase consumption in these economies - especially in countries such as China, India, and Brazil. These countries have a large young population and rising disposable income levels which implies that the propensity to spend on lifestyle choices is high. This is true not only of the soft drink and snacks market but also for the fruit juices and bottled water markets.
Activist investors are pushing to split the food and beverage businesses
PepsiCo has for nearly two years now battled activist investor pressure to spin-off its ailing beverage division, in order to, theoretically, allow the snacks division to unlock its true potential. Leading the push for separating the company's two businesses, was the activist investor, Nelson Peltz, CEO of Trian Partners hedge fund, which holds a 1.19% stake in PepsiCo. Last year, Peltz said that the company's stock could be worth $144 a share following a hypothetical spin-off. On the other hand, PepsiCo remained committed to deriving cost benefits from synergies between the two businesses, which the company says range between $800 million and $1 billion annually.
Investors in favor of the spin-off, argue that cost-cutting at each company, following the split, would more than make up for their current synergies. Cost-cuts resulting from the split, for example, such as a possible consolidation of PepsiCo's four U.S. headquarters into two, could result in lower corporate overhead for each company, and more than offset the present synergies. In addition, a trimmer business, especially the ailing beverage division, could potentially further expand margins and compete better with Coca-Cola.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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