PepsiCo’s (NYSE:PEP) snacks division has been a consistent performer over the last few years. By catering to the growing demand for healthier foods in developed economies and adapting to local tastes and preferences in emerging markets, the company has seen its share in the global packaged foods market improve significantly over the last 3-4 years. Despite this success, the company’s overall performance has been lackluster on account of its flagging beverage business. In 2012, the company’s total sales shrank by nearly 1.5% over the previous year while operating margin shrank by 60 basis points. We believe this weakness will persist given a combination of Coca-Cola’s momentum in some core markets and local competitive threats in some expansion markets.
The chief reason behind PepsiCo’s poor performance in the beverage segment has been its inability to keep pace with Coca-Cola’s (NYSE:KO) recent success. By keeping its focus limited to its core beverage business, Coca-Cola has been edging out Pepsi in both, emerging as well as developed markets. In the U.S., sales of Diet Coke overtook Pepsi-Cola in 2010.  Along with traditional Coke, Coca-Cola now holds the top two best-selling carbonated soft drinks (CSD) in the U.S. and holds a total market share of nearly 40%. Pepsi is a distant second with around 29%.  The story is repeated in key markets such as China and Brazil where Coca-Cola maintains a stranglehold over the CSD market. PepsiCo’s success in the snacks division, in some ways, has come at the cost of a loss in focus in the beverage department.
The situation is getting bleaker for Pepsi as its plans to expand in key emerging economies are being thwarted not only by Coca-Cola’s established presence, but the rise of cheap private labels which have close ties with local retailers. In Thailand, Pepsi is being pushed out by a new cola brand called ‘Est’. This new brand is being manufactured by one of PepsiCo’s former bottling partners with whom the company did not renew its contract. By leveraging its close ties with local retailers, the company has successfully reduced Pepsi’s share in the Thai market, from over 40% in 2011 to only 15% today. 
A similar story is playing out in Russia, PepsiCo’s second biggest revenues source after the U.S. Here it’s the company’s share of the juice market which has suffered. Instead of a single competitor, the problem with Russia is that retail chains are coming up with their own juice brands sourced from local vendors, and moving PepsiCo’s products off their shelves. As a result, Pepsi’s share in the country’s juice market has declined from 45% to around 40% in a span of one year alone. 
The combined effect of Coca-Cola’s established presence and the rise of private labels does not bode well for PepsiCo. Nevertheless, growth in the company’s snacks division should help offset some of these key challenges in the near future. But our own expectations from the beverage segment remains muted.
We have a price estimate of $76 for PepsiCo, which is line with the market prices.Notes: