PepsiCo Puts Trian Business Advisor On Board

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PepsiCo (NYSE:PEP) has for nearly two years now battled activist investor pressure to spin-off its ailing beverage division, in order to, theoretically, allow the snacks division to unlock its true potential. Leading the push for separating the company’s two businesses was the activist investor Nelson Peltz, CEO of Trian Partners hedge fund, which holds a 1.19% stake in PepsiCo. Last year, Peltz said that the company’s stock could be worth $144 a share following a hypothetical spin-off. On the other hand, PepsiCo remained committed to deriving cost benefits from synergies between the two businesses, which the company says range between $800 million and $1 billion annually. However, it seems that the two opposing sides have called a truce, with PepsiCo electing William Johnson, an advisory partner at Trian Fund Management, to its board. Peltz has said how the CEO Indra Nooyi’s commitment to operational excellence has helped PepsiCo improve its performance over the years. This new development could either mollify some of the pressure to spin-off beverages, or could possibly hand more power to Trian to force the issue, this time from the inside.

PepsiCo’s stock has jumped 18.5% in the last 52 weeks, beating the 10.4% growth by Coca-Cola’s stock. Some of the growth in PepsiCo’s stock can be attributed to increased operational efficiency, but rumors of a possible split were also instrumental in increasing the stock’s value in the last year. The company has exceeded analyst estimates for its earnings per share for eleven consecutive quarters now, and increased its full-year outlook on currency neutral earnings per share growth to 9% year-over-year from the previously estimated 8% growth, following the third quarter results. PepsiCo is looking to squeeze out higher shareholder return through productivity savings. The food and beverage giant is expected to have drawn an incremental $1 billion in savings in 2014, after saving $900 million in 2013, as part of its $3 billion savings program for the period of 2012-2014. Overall operating profit, with currency neutral, rose 5.5% year-over-year in Q3, as PepsiCo benefited from its savings plan and higher pricing. Now the company looks to save another $5 billion in the next five years, as part of its productivity savings plan for 2015-2019, by optimizing global manufacturing operations and simplifying organization systems to drive efficiency.

We estimate a $91 price for PepsiCo, which is roughly 6% below the current market price.

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See Our Complete Analysis For PepsiCo

There is room for further margin growth at PepsiCo it would seem, as the company’s operating margins stood at only 16.15% through Q3, lagging Coca-Cola’s margins of 23.5% during the same period. This might not seem like a valid comparison as Coca-Cola is a drinks-only business, while PepsiCo derives approximately 52% of its revenues from snacks. If we remove the snacks business from PepsiCo, operating margins for the company would in fact fall even further. Through September, margins for the Pepsi Americas Beverages (formed 32.2% of the net revenues through Q3) stood at 14.3%, whereas margins for Frito-Lay and Quaker Foods North America and Latin America Foods combined (37.5% of the net revenues) were 23.7%.

Should PepsiCo Split?

While the management believes that the combination of snacks and beverages yields higher cost-benefits, investors in favor of the spin-off argue how with the cost-cutting at each company, following the split, would more than make up for their current synergies. Cost-cuts resulting from the split, for example, a possible consolidation of PepsiCo’s four U.S. headquarters into two, could result in lower corporate overhead for each company and more than offset the present synergies. In addition, a trimmer business, especially the ailing beverage division, could potentially further expand margins and compete better with Coca-Cola. Carbonated soft drink (CSD) sales in the U.S. are expected to have declined for the tenth consecutive year in 2014, and with growing health and wellness concerns among consumers and absence of a “reliable” and “safer” low/no calorie soda substitute, CSD volume sales are expected to continue declining in the near term.

The company’s soft drink sales, which form around 17% of the net valuation, fell by 8% between 2011-2013, as CSD sales in developed markets continued to decline on the back of growing health and wellness concerns. On the other hand, sales for the snacks division, which forms 62.5% of PepsiCo’s valuation by our estimates, grew by 8% between 2011-2013. The snacks industry in the U.S. is still growing, and its industry value added (IVA) i.e. an industry’s contribution to the economy, is estimated to rise at a CAGR of 4.6% through 2019. [1] Drinks are on a decline volume-wise, while snacks are expected to continue growing, which brings into question whether PepsiCo should seriously consider splitting.

Peltz and Trian have in the last couple of years argued how PepsiCo and its thriving foods business would be better off as a standalone business, while the management believes otherwise. With Johnson on the board of PepsiCo, it remains to be seen if the investor pressure for a spin-off amplifies, or the whole topic gets pushed to the back burner.

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Notes:
  1. Snack food production in the U.S., Market research []