Non-Carbonated Beverages Spearhead Growth For PepsiCo’s North America Business

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While PepsiCo‘s (NYSE:PEP) snack offerings are considered the main drivers of the company’s organic volume sales growth, beverages are considered the slackers. The foods division, including the likes of Frito-Lay and Quaker Foods, forms 64.5% of PepsiCo’s valuation as per our estimates, fueled by relatively higher sales growth expectations and fatter margins for operating units, such as Frito-Lay North America — the most profitable division for PepsiCo. But this year, beverage growth has somewhat kept up with that in snacks, especially in North America, which contributes over 60% to the top line, and approximately two-thirds of the core division’s operating profit.

year to date growth organic pepsi

Much of this growth in North America beverages is helped by the boost in sales for its non-carbonated portfolio, which forms roughly 40% of the net volumes for this division. Through the first three quarters of 2015, a 5.5% growth in non-carbonated volumes more than offset the 2% decline in carbonated beverages, which still form the core of PepsiCo’s beverage business, but continue to witness subdued customer demand. As carbonated soft drinks (CSD) continue to bear the brunt of growing health concerns and customer skepticism regarding the usage of artificial sweeteners and/or bitter aftertastes of the diet/low calorie drinks, volumes in Q3 declined by 1% in regular soft drinks and by a steeper 6.5% in diets.

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We estimate a $99 price for PepsiCo, which is slightly below the current market price.

See Our Complete Analysis For PepsiCo

 

But while customers are shifting away from CSDs, what bodes well for PepsiCo is that they are shifting to other beverage segments such as sports drinks, ready-to-drink tea, and bottled water, where the company has significant presence, as well. Bottom line is that consumers are not drinking less, they are just not drinking sodas as much, anymore. So a more focused approach, marketing, and media investments behind brands such as Gatorade sports drinks, Lipton teas, and Tropicana fruit juices, is driving an increase in PepsiCo’s drinks volume.

The U.S. is the fastest growing bottled water market outside Asia, and forms around 35% of the country’s liquid refreshment beverage market. The bottled water segment is voluminous and promises growth, and through the first three quarters, PepsiCo’s water portfolio witnessed a double-digit percentage increase in North America. The company’s leading water brand Aquafina sells less than one-fourth the net volumes sold by Pepsi in the U.S. Aquafina had sales of $0.96 billion for the 52 weeks ending May 17 2015, holding 9.6% market share in the still water category (the largest bottled water category) in the U.S. [1]

 

However, the leader in this market is Nestlé Waters with a share of ~23% owing to successful brands such as Nestlé Pure Life, Poland Spring, Deer Park, and Ozarka. Water promises high volumes, but this category could be dilutive to the overall margins. However, innovations in this category such as value-added water, added minerals and carbonation, and premium brand perception, has allowed some brands such as Glaceau Smartwater (Coca-Cola brand) to rake-in higher revenues due to a greater average revenue-per-unit.

While CSDs still account for a hefty 41% of the overall market, this percentage share is down from 47% five years ago. Bottled water is the second largest segment, accounting for approximately 35% of the net beverage volumes sold in the country. But there are other segments too, such as sports drinks, that although constitute a small percentage of the overall volumes at present, are witnessing solid growth — growth that is lucrative enough to attract large beverage manufacturers. Sports drinks are marketed as thirst quenchers which are substitutes for water. The difference is that these drinks have additional minerals and electrolytes, which argue how consumers need more than just water to meet their hydration needs. This market, worth $6.81 billion, has grown at a CAGR of 3.8% in the last five years. In comparison, the U.S. LRB market has grown at an average of only approximately 1%. Gatorade has a mammoth 77% share of sports drinks in the U.S., and grew by another mid-single-digit percentage through Q3, to boost PepsiCo’s beverage results.

 

Another high growth category for PepsiCo is ready-to-drink (RTD) tea, which although forms only 4% of the U.S. beverage industry as of now, is expected to grow at a CAGR of 5% at constant 2014 prices, to reach sales of $6.6 billion by 2019. [2] The Pepsi-Lipton Tea Partnership led the RTD tea segment in off-trade value terms in 2014, with a share of 25%, followed by AriZona Beverage Company, which has a share of 24%.

Much of PepsiCo’s North America beverage sales is formed by CSDs, however, growth in segments such as bottled water, sports drinks, and RTD tea cannot be ignored. These segments are also typically accretive to margins, even bottled water, when we consider value-added or sparkling water.  CSD is a relatively mature market, where pricing is tight, and dependent on two or three players (Coca-Cola, PepsiCo, and Dr Pepper Snapple) who together hold close to 90% volume share. PepsiCo has witnessed solid growth in these non-carbonated segments, which has bolstered overall top line growth in the home market, in the absence of volume growth in CSDs.

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Notes:
  1. Market share of leading still water brands in the U.S., statista.com []
  2. RTD tea in the U.S., euromonitor.com []