Obstacles That Could Deter Growth For PepsiCo’s Snacks Division (Part 2)

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PepsiCo‘s (NYSE:PEP) snacks business constitutes just over 62% of the company’s valuation by our estimates. While the beverage segment, especially carbonated soft drinks (CSD), has suffered due to consumer health concerns regarding high calorie content, snack foods continue to grow for PepsiCo. Sales for the Frito-Lay snacks division in North America have increased consecutively in the last five years, and constituted over 21% of the net sales in 2013. Growth has been unwavering due to the large snacking habit of domestic consumers. However, the U.S. has the world’s second largest obesity rate of 31.8% and also a high diabetes rate. Health concerns in the country have already dragged down soda sales, and could soon catch-up to the junk foods category, consequently hurting PepsiCo’s snacks sales.

In the previous article, we highlighted the possible obstacles faced by snack foods in the U.S. The country which surpasses even the high obesity and diabetes rates of the U.S. is Mexico, the third largest market for PepsiCo. Recently imposed food taxes in Mexico could have a significant impact on PepsiCo’s snacks division going forward. On the other hand, dairy products are hugely popular in Russia, PepsiCo’s largest international market. Although consumer demand remains strong in Russia, inflation and unfavorable currency translations could slow revenue growth from the country.

We estimate a $86.82 price for PepsiCo, which is roughly in line with the current market price.

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Mexico Junk Food Tax Could Further Hurt Snack Sales

According to our estimates, PepsiCo’s food division generated close to $3.8 billion in Mexico in 2013, up over 10% year-over-year. Mexico food sales translated into 11.3% of all food revenues for the company, and close to 47% of food sales from Latin America last year. The Mexican savory snacks market is estimated to be worth nearly $5.5 billion last year. [1] Sabritas is the brand under which PepsiCo sells its Frito-lay snacks such as Doritos, Tostitos, Cheetos, as well as other products specific to the Mexican market (Rancheritos, Sabritas, Turbos Flamas, Pizzerolas and Sabritones). Sabritas dominates the country’s salty snacks market with close to 80% share, followed by Barcel, a maker of tortilla potato chips and other snack brands, which accounts for only 12% market share. [2]

PepsiCo already has a stronghold in Mexico and further announced a $5 billion investment in the country earlier this year, in addition to the $3 billion already invested since 2009. [3] However, the Mexican government passed a “junk food tax” late last year, to entail an 8% rise in prices of foods with high amounts of saturated fat, sugar and salt. With more than half the country’s population living below the national poverty line, a rise in junk food prices is expected to dissuade some price-sensitive customers from consumption. [4] Following the imposition of this tax, PepsiCo’s organic revenues from the foods business in Mexico declined by a low-single-digit percent in the first quarter. This fall in Mexico sales came after several consecutive quarters of growth, and is expected to continue to negatively impact the company’s business this year.

Currency Headwinds And Inflation Could Impact Russia Sales

Russia is PepsiCo’s largest international market, contributing $4.9 billion to the company’s top line last year. While beverage volumes declined in Russia, snacks witnessed a low single-digit-percent growth last year. In the first quarter, Russia was the growth driver for PepsiCo with 10% year-over-year rise in organic sales, led by the snacks division. [5] However, net revenues from the country declined in Q1 over 2013 levels due to unfavorable currency translations. The Russian ruble has depreciated nearly 6% against the U.S. dollar since the beginning of this year. Geopolitical issues in the country could lead to further economical and operational instabilities, and result in further devaluation of the ruble. Thus, currency headwinds could drag down PepsiCo’s revenues from Russia going forward.

In 2011, PepsiCo had acquired Wimm-Bill-Dann, one of Europe’s leading dairy products company, in a bid to take advantage of the dairy potential in the Eastern Europeans markets. The dairy market in Russia is estimated to be worth $16 billion presently, and is expected to cross $20 billion by 2017. [6] Yogurt is the third largest segment in this market after milk and cheese, accounting for just over 20% share. [7] However, high inflation rates could be a dampener for PepsiCo in Russia in the coming months. Inflation is expected to peak to 7.5% in the country by mid-year, with prices of milk and cheese reaching their highs in the next few months. [8] Amid high costs of raw materials, PepsiCo and its counterparts have had to raise product prices in order to protect profitability. Price rise could deter dairy demand in Russia, and stall growth for PepsiCo this year. Danone, a leading dairy products manufacturer, has already been hit due to inflation as its fresh dairy volumes declined by 3.7% in the country through March. [9] We expect currency headwinds and dairy inflation in Russia to weigh on PepsiCo’s financials this year.

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Notes:
  1. Savory snacks in Mexico“, October 2013, reportlinker.com []
  2. The PepsiCo family“, pepsico.eu []
  3. Pepsi announces plans for $5 billion investment in Mexico“, wsj.com []
  4. Poverty headcount ratio at national poverty line“, worldbank.com []
  5. PepsiCo earnings transcript“ []
  6. Russia- dairy“, September 2013, datamonitor.com []
  7. The Russian dairy market: what consumers eat and why“, January 2014, prnewswire.com []
  8. Finance ministry forecasts Russia’s y-o-y inflation at 7.2-7.3%“, April 2014, brics-info.org []
  9. Danone drops in Paris on declining fresh dairy shipments“, April 2014, bloomberg.com []