Pepsi’s $71 Fair Value Driven by Snacks in EM & Soft Drinks Push

Although PepsiCo (NYSE:PEP) is increasing its marketing spend to boost flagging soft drink sales, the stock’s true value is likely to come from its snack business via the Frito-Lay segment. PepsiCo’s recent acquisitions in strategically key locations gives it a strong platform and ensures long term growth of the company. What many will find surprise is that Frito-Lay’s contribution to the overall stock price is almost half of the value while the soft drink segments make up a far smaller share of its value according to our analysis. PepsiCo competes with leading food & beverage companies around the world including Kraft Food (NYSE:KFT), Coca Cola Co (NYSE:KO) and Dr Pepper Snapple (NYSE:DPS).

See our complete analysis of PepsiCo

Investments in Emerging Markets The Key

Frito-Lay will introduce its corn-based snacks in India which the company sells under the brand name Doritos. The company is pumping in more than $100 million build a plant in India to manufacture corn-based snacks that will see the total manufacturing capacity rise by about 15% in the country. ^[1] The move will help the company extend its line of offering in the country which currently includes Lays chips and the locally acquired Kurkure, among others. Pricing is a major issue in India and companies often find themselves surviving on thin margins to drive up volumes.

Given its brand name, marketing muscle and the distribution network, PepsiCo is one of the few companies which can maintain healthy margins even with low pricing. Also, adding products to the portfolio will be less burdensome financially as the company can use its existing supply chain and distribution networks.

After acquiring Brazil’s Grupo Mabel last year, the company is looking to buy Marilan, the country’s fourth largest cookie maker. These 2 acquisitions would represent almost $1 billion of investments in a nation which is the second largest cookie and cracker producer in the world. The international salted snacks market is currently worth $37 billion and will rise to $40 billion by the end of 2015.

Reinvigorating Soft Drinks

PepsiCo has stepped up efforts to boost sales of its weak soft drink sales in the U.S. The company is focusing on increased marketing of its drinks Pepsi, Diet Pepsi and 7Up. The latest Diet Pepsi commercial features the curvaceous actress Sofia Vergara to widen its appeal to mainstream public and not just health conscious consumers. ^[2] The company’s namesake brand Pepsi is spending millions on commercials in the Superbowl this year. This marketing push extends to developing countries as well. In India, the company is doing image makeover of 7Up by giving it a new packaging and logo and will soon come up with a commercial featuring a Bollywood star. According to recent reports, the company plans to spend $400 million on marketing alone this year.

Even with the increased marketing push, it will take some time before the move begins to show its results. Unforeseen events like the recent lawsuit on Mountain Dew claiming a mouse came out of an opening can adversely affect the sales, albeit, temporarily.

There have also been reports that PepsiCo might consider splitting up the company into two i.e. a separate division for snacks and beverages each, but the company has quashed such rumors. Instead, the company plans to cut jobs to improve the efficiency and reduce costs.

PepsiCo is under pressure to increase the margins as the costs soared last year and the beverage sales in the North America remained more or less the same. ^[3]

We maintain a price estimate of $71, which is about 10% above the current market price.

1. PepsiCo plans to serve up corn-based snacks, The Hindu, January 11, 2012 [↩]
2. Sofia Vergara stars in new Pepsi ad, Ontheredcarpet.com, January 12, 2012 [↩]
3. PepsiCo Said to Plan Job Cuts to Boost Profits as Stock Lags, Bloomberg, January 6, 2012 [↩]