Leading snacks and beverage manufacturer, PepsiCo (NYSE:PEP) reported net revenue growth of 1% in Q4 and the full year.  As expected, declining soda sales in North America and unfavorable currency translations weighed on the company’s financials. Although core earnings increased 10% year-on-year to $4.32 per share, beating consensus estimates of Wall Street analysts, revenue growth was short of the expected mid-single percent rise over 2012. The company derived growth mainly from its booming snacks business and emerging markets such as China, Mexico, Brazil and Pakistan. According to PepsiCo, this bodes well for its growth prospects as the company expects two-thirds of its revenue growth to come from the snacks division (business wise) and developing countries (geography wise) in the coming year. 
We estimate a $87 price for PepsiCo, which is around 10% above the current market price. However, we are currently in the process of revising our price estimate to incorporate the latest earnings.
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- North America Beverages Continue To Decline
Revenues for PepsiCo’s North America beverage division declined by 2% and by 3% in terms of volumes year-on-year. Category headwinds in carbonated soft drinks (CSD) continued to impede growth in this category, with diet drinks recording the steepest decline. Due to problems of bitter aftertastes and health and wellness concerns over safety of the artificial sweetener aspartame, diet fizzy drinks remained the most underperforming segment of the overall U.S. liquid refreshment beverage (LRB) market. Unit sales of low calorie versions of the company’s flagship brands Pepsi and Mountain Dew fell by over 4% in the U.S. convenience stores in 2013, while unit sales in the overall CSD category declined by 1.4%. 
However, unlike its chief competitor, The Coca-Cola Company (NYSE:KO), PepsiCo has a strong presence in the snacks market apart from beverages. In fact, around 60% of the company’s valuation comes from its snacks division by our estimates. As consumers slowly shift from sugary drinks to healthier alternatives such as sports drinks, carbonated water and even energy drinks, traditional CSD making companies have struggled to maintain their market share in the U.S. LRB market. But the bright spot for PepsiCo is that the core cola segment in CSDs, which is declining at a fast rate, forms only 15% of the company’s North America business. In addition, PepsiCo has a stronghold in the fast growing sports drinks segment, which is one of the segments that are taking away market share from CSDs. The company’s brand Gatorade constitutes close to three-fourths of the total volumes in sports drinks in the domestic market. According to our estimates, this segment will grow at a CAGR of 6.5% to over 2 billion gallons in 2018, constituting 6.1% of the U.S. LRB market, up from 4.6% in 2012.
- Emerging Economies Provide Growth For Beverages
While fizzy drinks continue to decline in most developed markets, this segment is still growing in the emerging economies in Asia, Middle East and Africa. Organic revenue in this region grew by 11% in Q4 and the full year bolstered by increasing disposable incomes and a growing middle class. The company witnessed a promising double digit percent increase in China and a high single digit percent increase in Mexico in volumes last year. Mexico is crucial for PepsiCo as it is the company’s third largest market behind the U.S. and Russia. However, the recently imposed taxes on sugary drinks in the country could hamper growth for PepsiCo in the coming year. The Mexican government imposed taxes of one peso (~7.5 cents) on one liter of sugary drinks late last year. This move aims to fight raging health problems in Mexico, which has the highest obesity rate in the world at 32.8%.
Apart from accelerating beverage operations in international markets, PepsiCo also hopes to revive its CSD sales in the domestic market by introducing naturally sweetened fizzy drinks in 2014. The company has tested several naturally sweetened zero calorie versions of its cola drinks, which it plans to launch in the U.S. this year. Natural sweeteners are considered to have tackled the problem of bitter aftertastes and might be able to spur sales of CSDs going forward.
- Frito-Lay North America Continues To Drive Growth
Organic revenues for PepsiCo’s Frito-Lay North America division grew 7% to over $14 billion last year, while volumes rose by 3%. The sweet and savory snacks market in the U.S. had retail sales of around $40 billion in 2012, with sales of salty snacks (including potato chips, tortilla chips and corn snacks) increasing by over 4% year-on-year.  Frito-Lay holds a commanding position in this market, accounting for 42% of the market share by value. The largest segment of the salty snacks market is potato chips, which contributed sales of $9 billion in 2012.  Fueled by the introduction of baked and gluten-free chips, this segment is expected to grow at a CAGR of 3.1% through 2017.  This means well for PepsiCo, which boasts a market share of 58% in potato chips and could draw dollar sales of over $5.5 billion from this segment alone by 2017, given the present scenario.
However, due to growing health concerns over consumption of high cholesterol filled salty snacks, this estimate could be somewhat offset. The U.S. has a high obesity rate of 31.8% in addition to a high diabetes rate of ~8%. The effect of these concerns has already been seen on sugary beverages in the U.S., which declined for the ninth consecutive year, and could also negatively impact salty snacks in 2014.
- Demand For Quaker Foods In North America Falls
Amid declining demand for hot cereals in the U.S. breakfast cereal market, sales of the brand Quaker Foods decreased by 2% in Q4 and by 1% in the full year. This is primarily due to shifting trends in the breakfast cereal industry, where compact foods and ready-to-eat nutritional snack bars are gaining more popularity as compared to traditional hot cereals. At present, General Mills and Kellogg’s lead the U.S. breakfast cereal market with a combined share of over 55%, but Quaker Foods leads the hot cereals segment. The overall market is expected to grow at a CAGR of 3% to $10.3 billion in 2017.  However, despite the growth potential of this market, what hurt sales of Quaker last year and could continue to negatively impact its growth in 2014, is the decline in volumes of the hot cereals segment.
PepsiCo Announces Its Productivity Plan and Commitment To Beverages
PepsiCo announced its five-year productivity savings plan for 2015-2019, according to which the company plans to save $1 billion each year by optimizing global manufacturing operations and simplifying organization systems to drive efficiency. The company already saved $900 million in 2013 as part of its savings program for the period of 2012-2014. Operating margins for 2013 stood at 14.6% and could further increase this year if the savings plan is successfully met.
The CEO of PepsiCo, Indra Nooyi, dismissed all proposals led by activist investor Nelson Peltz to spin-off the North America beverage division. Despite declining soda sales and ongoing criticism of sugary drinks including juices, the company remains hopeful to revive its beverage sales in the domestic market by introducing naturally sweetened low sugar drinks and accelerating investments in marketing and innovation in the fast growing sports drinks segment.Notes:
- “PepsiCo 8-k“ [↩]
- “PepsiCo earnings transcript“ [↩]
- “CSD sales down 1.4% in c-stores in 2013“, February 2014, cspnet.com [↩]
- “Sweets and snacks 2013 trends“, May 2013, cnbc.com [↩]
- “Salty snacks-US“, January 2013, marketresearch.com [↩]
- “Potato chips in the US“, September 2013, marketresearch.com [↩]
- “Breakfast cereals in the U.S.“, March 2013, euromonitor.com [↩]