PepsiCo’s Investment In Mexico Comes In The Wake Of Possible CSD Slowdown

Citing growth potential in Mexico, PepsiCo (NYSE:PEP) announced its plans to invest $5 billion in the country over the next five years at the World Economic Forum in Davos. ^[1] The company has already invested around $3 billion in Mexico during the last five years. With this move, the beverage giant has clearly signaled its intent to accelerate its operations in the country. With a growing middle-class and a large appetite for sugary drinks, Mexico provides growth opportunities. However, health concerns might hinder growth of PepsiCo’s beverage business in the country. Mexico is already the third largest market for PepsiCo behind the U.S. and Russia, contributing ~$4 billion to the company’s overall revenues of $65 billion in 2012. ^[2]

We estimate a $87 price for PepsiCo, which is around 5% above the current market price.

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Sodas Are A Hit In Mexico For Now

The beverage market in Mexico (includes concentrates apart from finished drinks) was worth $39.2 billion in 2012, growing at a CAGR of 6.4% between 2008 and 2012. ^[3] The country is a major consumer of soft drinks, especially carbonated soft drinks (CSD), with over 146 liters of CSDs consumed per person in 2012. In this respect, Mexico trails only the U.S., which has a massive per capita consumption rate of 165 liters.

However, in recent times, the U.S. has tried to shake its CSD habit due to looming health concerns such as obesity and heart problems. Following which, the carbonates segment in the country has shown flat to negative growth in the last few years. PepsiCo’s CSD volumes in North America decreased by 4% year-over-year in 2012 and by 6% through the nine months ending September 2013. In contrast, the carbonates segment has continued to increase in Mexico, although growing moderately compared to relatively nascent categories such as ready-to-drink (RTD) teas, sports and energy drinks. In fact, the per capita CSD consumption has improved to 162 liters presently. This has helped PepsiCo’s Mexico volumes to witness mid-single-digit increases in 2012 and through September 2013.

Carbonates and especially cola drinks are hugely popular in Mexico, partly due to the absence of easily available clean drinking water. Growing middle-class and rising disposable incomes might further increase soda consumption in the next few years. However, the demand for CSDs in the country could slow down on account of the following factors:

• Alarming Obesity And Diabetes Rates:

High consumption rates of sugary drinks are closely followed by health risks. As seen in the U.S., where a whopping 36% of the population was obese in 2012, CSD sales declined by nearly 3% during 2010-2012. Mexico also had 33% of the population suffering from obesity in 2012. In just over a year, while obesity rate for the U.S. has fallen to 31.8%, Mexico is now shouldering the world’s highest obesity rate of 32.8%. In addition, Mexico also has a high diabetes rate (percentage of population with diabetes) of 9% as of 2012, compared to a 7.7% diabetes rate in the U.S. ^[4]

• Tax Imposed On Sugary Drinks:

The Mexican President, Enrique Peña Nieto, announced significant new taxes on sugary drinks late last year. ^[5] In a bid to fight health problems in the country, an added tax of one peso (~7.4 cents) on a liter of fizzy drinks has been imposed. This tax will be passed on to consumers and thus raise CSD prices, as beverage companies will look to maintain margins. Increased prices might somewhat hamper demand for sugary drinks in Mexico.

• Large-scale Negative Marketing Against CSDs:

The President also called for a “change in culture” in Mexico and urged people to exercise more and drink less sugary drinks. Apart from obesity campaigns in the country, specific advertisements against CSDs have also been issued in public interest. Last year, a series of ads showed 12 spoonfuls of sugar next to a 20-ounce cola drink with a tagline asking, “Would you eat 12 spoonfuls of sugar? Why do you drink soda?”. These advertisements were seen pasted across buses, billboards and also along subway platforms, in hope to incite negative sentiment against fizzy drinks.

PepsiCo’s Growth Prospects In Mexico

According to our estimates, beverages contributed ~$500 million to PepsiCo’s overall revenue from Mexico in 2012. Although the company has an established presence in Mexico, it has a small share of ~12% in the country’s beverage market. This figure is dwarfed by the 60% market share of Coca-Cola. In 2012, Coca-Cola had announced its plans to invest $5 billion in Mexico through 2017. In addition, Nestle also said that it will spend $1 billion in the country over a period of five years at Davos. ^[6]

With plans for a $5 billion investment, PepsiCo eyes an improvement in its market share by focusing on innovation, research and development of its brand in Mexico. The beverage giant has also planned to increase its production capacity by adding new manufacturing lines and improve its distribution channels. However, a possible slowdown in CSD demand could offset any improvement in Pepsico’s beverage market share in the country. Going forward, meaningful growth for PepsiCo could come from sports drinks. The company’s flagship brand Gatorade leads the sports drinks category in Mexico with an 86% market share. ^[7]

Growth Could Come From Sports Drink ‘Gatorade’

What works for sports drinks in Mexico is everything that doesn’t work for CSDs. As health concerns target consumption of sugary drinks, consumers might shift to healthier options such as sports drinks. In addition, added taxes on CSDs will narrow its price gap with sports drinks, given that the latter is generally more expensive. As sports drinks are marketed as thirst quenchers and a possible replacement for water, unavailability of clean tap water in Mexico could also boost its sales. This category is relatively new as of now, and therefore, presents huge growth opportunities for PepsiCo, which already boasts a stronghold in this market.

Sugary drinks constituted roughly 32% of the Mexican liquid refreshment beverage (LRB) market in 2012 in terms of volumes by our estimates. Fueled by the possible slowdown of CSDs, growth of the overall Mexican LRB market is expected to decelerate. This market is expected to grow at a CAGR of 5.6% through 2017 to $51.5 billion. In the U.S., sports drinks are relatively more popular and had retail sales of $6.3 billion in 2012, with PepsiCo grabbing more than three-fourths of this market. If sales of sports drinks gain traction in Mexico and manage to capture ~1% of the country’s LRB market by 2017, and assuming that PepsiCo maintains its market share, the company could generate over $500 million a year starting 2017 from this category alone.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. “Pepsi announces plans for $5 billion investment in Mexico“, wsj.com [↩]
2. “PepsiCo 10k“ [↩]
3. “Mexico-soft drinks“, September 2013, datamonitor.com [↩]
4. “Health battle over soda flares in Mexico“, August 2013, wsj.com [↩]
5. “Mexico to tackle obesity with taxes on junk foods and sugary drinks“, theguardian.com [↩]
6. “Pepsi, Nestle to invest in Mexico“, wsj.com [↩]
7. “Sports and energy drinks in Mexico“, March 2013, euromonitor.com [↩]