VALUATION HIGHLIGHTS

1. Frito-Lay North America constitutes 40% of the Trefis price estimate for PepsiCo's stock.
2. North America Beverages constitute 21% of the Trefis price estimate for PepsiCo's stock.
3. Latin America constitutes 17% of the Trefis price estimate for PepsiCo's stock.

WHAT HAS CHANGED?

1. PEP Stock Performance

   PEP stock has witnessed gains of 15% from levels of $150 in early January 2021 to around $170 now, vs. an increase of about 35% for the S&P 500 over this roughly 3-year period.
   However, the increase in PEP stock has been far from consistent. Returns for the stock were 17% in 2021, 4% in 2022, and -6% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 - indicating that PEP underperformed the S&P in 2021 and 2023.
   



2. Latest earnings (Q4 2023)

   PepsiCo reported revenues of $27.85 billion in Q4 2023, marking a y-o-y decline of 0.5%. Organic revenue growth was 4.5%, driven by a 9% rise in pricing, offsetting a 4% decline in volume. PepsiCo reported a net income of $2.5 billion, or $1.78 per share, up from $2.3 billion, or $1.67 per share, a year earlier.



3. 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 separation of the foods and drinks divisions might be in the cards sometime 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 in 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.



4. 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 ounces and snacks with low levels of sodium and saturated fat.
   PepsiCo is also investing in advanced manufacturing technologies, like its proprietary frying innovation that reduces 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 20 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 toward 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, up 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.
   

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. However, the metric declined in recent years to 28.5% in 2022. We expect long-term margins to rise to over 32%. If PepsiCo's planned productivity savings and restructuring costs do not yield the desired results and the margins fall under 27%, we could see the Trefis price estimate revised downward by 15%.

BUSINESS SUMMARY

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 Coca-Cola Co. in virtually all sub-segments of the beverage market. Both 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 companies have competing brands - which closely resemble each other - in all market segments.

SOURCES OF VALUE

We believe that Frito-Lay, Quaker Foods, and other food products, constitute 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.

KEY TRENDS

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 the 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 toward 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.