PepsiCo’s Bittersweet Symphony: Sugar Variants Might Save Ailing Sodas In Time

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While PepsiCo‘s (NYSE:PEP) booming snacks division posted a 3% year-on-year rise in revenues in 2013, sales for the beverage division declined by 1%. In fact, revenues for the ailing beverage division have fallen by 8% in the last couple of years, primarily due to headwinds in the core carbonated soft drinks (CSD) category. According to our estimates, CSDs in the Americas constituted roughly 15% to PepsiCo’s top line in 2013, down every year since 2010. As consumers continue to opt for healthier beverage alternatives such as carbonated water, natural fruit juices and even coconut water, sodas declined for the ninth consecutive year in 2013 in the U.S. This category might be headed for another tough year, as soda taxes in states such as California and Illinois, if passed, will almost double the price of a 24-pack soda case. A one-peso-per-liter soda tax is already in effect in Mexico, the impact of which is expected to lower CSD sales in the country this year. But despite the declining demand for sugary drinks, PepsiCo remains committed to this category, and has planned new launches this year in hope to spur sales. In particular, the company aims to strike the right “sugar” formula in diet soft drinks, which was the most underperforming category in the U.S. last year.

We estimate a $87 price for PepsiCo, which is around 6% above the current market price.

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Diet Drinks Haven’t Addressed Looming Health Concerns

With growing health and wellness concerns, consumers have looked to shake-off their soda habit in the last few years. High rates of obesity and diabetes have fueled the shift from regular CSDs, which contain around 150 calories per 12 ounce. However, diet versions of these sugary drinks have performed even worse, with retail sales of diet colas and diet citrus drinks falling 7.2% and 7.8% year-on-year respectively through November 2013. [1] Studies have argued that the artificial sweetener “aspartame” used in diet drinks can cause serious health problems along with sugar cravings, dehydration and even weight gain. [2] Companies now look to use natural sweeteners such as extracts of the stevia plant in their diet offerings. “Reb A” is a stevia extract made by PureCircle, a leading supplier of stevia derivatives, which has a supply agreement with PepsiCo. However, Reb A used in Pepsi Next has been criticized for its bitter aftertastes. Pepsi Next was introduced in Australia in 2012, but the version launched in the U.S. contains three artificial sweeteners and high fructose corn syrup.

New Natural Sweeteners Might Spur Diet Soda Sales

The Flavor and Extract Manufacturer Association has now cleared the use of “Sweetmyx” in diet soft drinks. [3] Sweetmyx, made by Senomyx Inc., is essentially an ingredient that will modify flavor characteristics within the drink mix to increase sweetness. This means that while Sweetmyx will reduce the amount of sugar required, it is not a sweetener in itself. This bodes well for PepsiCo, which holds exclusive rights to use this flavor enhancer in its soft drinks. The company plans to launch low calorie CSDs that will use Sweetmyx this year.

Another development that took place last year was the FDA approval of the usage of “Reb D” in beverages. [4] Reb D is another stevia extract made by PureCircle, but unlike Reb A, it is present in minute quantities in the stevia plant. Reb D also poses a problem of low solubility in water at room temperatures, which would then require added sugar to keep up sweetness levels. This also means that this extract can’t be used in concentrates such as powders or syrups. However, in a patent application filed by PepsiCo last year, the company reported methods of enhancing Reb D’s solubility from 300-450 ppm (parts per million) to even 8,000 ppm. The company also said that Reb D has significantly higher sweetness and lower bitterness levels as compared to Reb A. In fact, Reb D is 270 times sweeter than sucrose, according to Purecircle. [5] As PureCircle plans to commercialize Reb D this year, PepsiCo will look to adopt this natural sweetener in its low/no calorie CSDs in hope to improve sales.

PepsiCo announced the introduction of naturally sweetened sodas in the non-cola segment this year, with cola products following suit later on. Unit sales of the diet version of the flagship flavored drink Mountain Dew fell by over 5% in the U.S. convenience stores last year. [6] Aiming to revive sales of diet soft drinks, PepsiCo might look to introduce Reb D or Sweetmyx with Mountain Dew and other flavored CSDs (7Up and Mirinda) in 2014.

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Notes:
  1. Soda sales are losing their fizz“, December 2013, money.cnn.com []
  2. Intake of sugar-sweetened beverages and weight gain“, National Institute of Health, United States []
  3. Senomyx approval to let pepsico use sweetmyx enhancer“, March 2014, bloomberg.com []
  4. Stevia innovation: Pepsico tackles Reb-D solubility challenge“, October 2013, foodnavigator-usa.com []
  5. relight my (cola) fire? FDA approves PureCircle Reb D stevia“, July 2013, beveragedaily.com []
  6. CSD sales down 1.4% in c-stores in 2013“, February 2014, cspnet.com []