- Frito-Lay North America constitutes 42% of the Trefis price estimate for PepsiCo's stock.
- North America Beverages constitute 20% of the Trefis price estimate for PepsiCo's stock.
- Europe Sub-Saharan Africa constitutes 15% of the Trefis price estimate for PepsiCo's stock.
WHAT HAS CHANGED?
Update on the latest earnings (FY2020)
PepsiCo reported a 4.8% rise in net revenue in FY2020 on the back of a strong Q4 where sales increased 8.8%. Higher revenue was driven by healthy growth in sparkling water, healthy snacks, and non-carbonated beverages, along with benefits from selling its snacks and beverages in smaller packaging, allowing it to charge more per ounce while appealing to customers who want smaller portions. Africa, Middle East, and South Asia unit saw the largest increase in net revenue. Adjusted earnings came in at $5.52 per share in FY 2020, almost similar to $5.53 in the year-ago period. Despite the coronavirus crisis, the company is expected to return almost $5.9 billion of cash to its shareholders in the form of dividends and share buybacks.
Good performance by drinks might mean PepsiCo is remaining intact
Revenues for PepsiCo are roughly split evenly between drinks and snacks, but the latter is growing faster, and is more profitable, which is why the contribution of the foods division to PepsiCo's overall value is more than the beverages division. As a result, the company has been under pressure over the last few years from activist investors to spin off the ailing beverages division, and allow the foods business to operate as a single separate unit.
Although segregation of the foods and drinks divisions might be in the cards some time later, it seems that PepsiCo is committed to deriving synergies between the two businesses for the current time, and is heading into the future intact, at least for now.
Beverages aren't growing as fast as snacks, but this segment has seen growth recently, not only in developing economies, but also developed markets such as the U.S., and the synergies cannot be ignored. For example, according to PepsiCo, a significant part of growing the snacks business includes penetrating all retail outlets that beverages are already in, because the company's presence in beverage retail outlets is much higher than in snacks. Apart from leveraging PepsiCo's higher beverage reach to grow snacks, too, what the company stands to gain from keeping the two businesses together are synergies.
Performance of Core Beverages Remains Weak
While PepsiCo has moderately increased media spend over the past three years, its biggest competitor – Coca-Cola – has done so by a substantial margin. While this has benefited the latter, PepsiCo has struggled as a result. In response to this, the company has allocated increased media to trademark Pepsi. It has also launched a new "Pepsi Generations" campaign, with PepsiCo expecting improving sales and market share as an outcome. Improvements in the division are already beginning to show, although the revenues are still on the decline. On the other hand, this step could also pressure the operating margins of the company, offsetting any benefit received from the productivity initiatives implemented by the company to induce cost savings.
Healthier options are a key for PepsiCo
Nutrition products form ~28% of PepsiCo's net revenue. These include positive nutrients like grains, fruits & vegetables, or protein, and those that are naturally nutritious like water and unsweetened tea.
Guilt-free products form ~45% of the net revenue. These include everyday nutrition products plus diet beverages and other beverages with fewer than 70 calories per 12 ounce and snacks with low levels of sodium and saturated fat.
PepsiCo is also investing in advanced manufacturing technologies, like its proprietary frying innovation that can reduce the amount of fat in potato chips by 20%. Healthier options are expected to buoy the company's top line growth in the future.
Soda consumption in the US has been declining for the past 12 years, as consumers look toward healthier options. Hence, a focus on these beverages has been a necessary move for PepsiCo. As it adapts to changing consumer preferences, PepsiCo believes that healthier products will be key for long-term growth. In order to meet the evolving needs of customers globally, the company is shifting its beverage portfolio towards these healthier beverages and aims for two-thirds of its global beverage portfolio volumes to contain fewer than 100 calories from added sugar per 12-ounce serving, from 40% currently. However, while the focus on healthier products is imperative, given the evolving needs and preferences of customers, PepsiCo still garners a significant portion of its revenues from its beverages, and hence, is a segment that needs to be protected.
2019 Productivity Plan
The company announced its new 2019 Productivity Plan on February 15, 2019. This plan will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer its go-to-market and information systems, including deploying the right automation for each market; simplify its organization and optimize the manufacturing and supply chain footprint. The company expects to incur pre-tax charges of approximately $2.5 billion, of which $138 million is included in 2018 results, approximately $800 million is expected to be reflected in the 2019 results and the balance to be reflected in the 2020 through 2023 results.
POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE
Below are key drivers for PepsiCo that present opportunities for upside or downside to the current Trefis price estimate:
Frito-Lay EBITDA Margins
- Frito-Lay North America EBITDA margins: Margins in this segment have benefited from higher sales, productivity initiatives, and lower commodity costs, primarily cooking oil and corn. The metric grew from 30.1% in 2013 to 33.9% in 2018. We expect long-term margins to rise to around 34.6%. However, if PepsiCo's planned productivity savings and restructuring costs do not yield the desired results and the margins fall to 27%, we could see the Trefis price estimate revised downwards by 10%.
PepsiCo is the world's second largest carbonated soft drink manufacturer and the largest packaged foods product manufacturer. Additionally, it owns a number of other businesses - ranging from fruit juices and other non-carbonated drinks to bottled water, and breakfast cereal.
PepsiCo's most important divisions are Frito-Lay North America and North America Beverages.
PepsiCo's beverage division competes with the Coca-Cola Co. in virtually all sub-segments of the beverage market. Both the companies have been operating for more than a century and compete fiercely across the globe - this fierce rivalry is termed as the Cola Wars. Its flagship brand is Pepsi - the second largest selling CSD (carbonated soft drink) globally - which just trails behind Coca-Cola's flagship brand Coke. Apart from Pepsi, both the companies have competing brands - which closely resemble each other - in all market segments.
In early 2010, PepsiCo completed its merger with major bottlers, Pepsi Bottling Group, and PepsiAmericas, to strengthen its bottling and distribution operations and gain from expected synergies.
SOURCES OF VALUE
We believe that Frito-Lay, Quaker Foods, and other food products, constitutes the most important component of PepsiCo's value:
Frito-Lay has a virtual monopoly in some market segments
Frito-Lay enjoys a virtual monopoly in many sub-segments of the packaged foods market, especially in the US where it owns most of the top-selling brands -- Cheetos, Doritos, and Tostitos being a few examples. From potato chips and tortilla chips to wafers, Frito-Lay commands a dominating position in all market segments. Increasingly, it derives a significant portion of its revenues from new, untapped, and unsaturated markets such as China and India, where traditionally, the general population has not been too exposed to the idea of instant snacks.
PepsiCo has been able to withstand negative publicity around the unhealthy nature of its food products
As with soft drinks, there has been an increased focus on the unhealthy nature of instant snacks. Allegedly, these food products promote binge eating and unhealthy eating habits - especially, in young children. However, PepsiCo has been able to face this increased scrutiny reasonably well. Most of the attention is focused on the likes of McDonald's. For example, Frito-Lay has increased its marketing efforts to counter this campaign. It has also managed to introduce a new line of healthier snacks. Furthermore, Frito-Lay has decided to label its products as gluten-free in order to appeal to gluten-sensitive consumers. In addition, PepsiCo, along with Germany's Theo Muller, has also launched yogurt and dairy products in the U.S.
Increased focus on the negative health impact of soft drinks is likely to curtail consumption
Over the last few years, there has been an increased focus on rising obesity levels in the general population due to unhealthy eating habits. This is particularly true in developed economies like the US and Western Europe where a heavy consumption of fast foods and soft drinks has been blamed for rising obesity levels. This has been especially prevalent among children. As a result, a number of organizations and even local government institutions have increased efforts to curtail consumption of these unhealthy foods. For example, a number of schools and educational institutions have even banned the sale of soft drinks on their premises. The soft drink manufacturers have sought to hit back by aggressive marketing and by promoting alternative healthier drinks. We expect the balance in the beverages market to shift gradually towards non-carbonated soft drink consumption.
Emerging economies are likely to drive growth
Unlike in the developed world, soft drink consumption in emerging economies is still low - the market is unsaturated, especially when seen from a per capita consumption point of view. Over the last few years, both PepsiCo and Coca-Cola have stepped up efforts to increase consumption in these economies - especially in countries such as China, India, and Brazil. These countries have a large young population and rising disposable income levels which implies that the propensity to spend on lifestyle choices is high. This is true not only of the soft drinks and snacks market, but also for the fruit juices and bottled water markets.