Can PepsiCo Leverage Its Snacks Business To Save Pepsi Cola?

In a previous article, we discussed how PepsiCo (NYSE:PEP) is planning to ramp up its presence in China through multi-billion dollar investments over the next few years. A key priority for the company in China is improving its understanding of the market – identifying the right mix of tastes that will help it displace the local competition who seem to have a pretty good hold over the market presently. To do this, the company set up an R&D facility in Shanghai earlier this year. And now, the facility seems to be rolling out some interesting concepts such as the radical-sounding new Pepsi and Chicken-flavored potato chips.

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Can Snacks Rescue Drinks?

PepsiCo’s gamble with this particular flavor may or may not pay off in the long run, but the move highlights that the company is willing to take risks in order to gain market share in foreign markets – and this is definitely good news for investors. More importantly, perhaps, the launch of a beverage-flavored snack underlines the company’s long-term vision of combining the respective brand values from Lay’s and Pepsi Cola into a single message for consumers. PepsiCo calls this strategy ‘drinkifying snacks’ – a term which basically highlights the company’s belief that snacks and beverages are not two, disparate entities but the two arms capable of generating brand synergies. ^[1]

PepsiCo has essentially been a tale of two parts in recent years – a profitable, well-performing snacks division spearheaded by Lay’s and a beverage segment losing out to Coca-Cola Co (NYSE:KO) in most countries. The company has been under some pressure to consider a split in its operations. Declining earnings over 2011-12 haven’t really helped either. Results from the latest quarter reveal that operating profit for the nine month period of Jan-Sept 2012 was 7% lower than the previous year’s figure, while total sales has shrunk by around 2%.

Company’s Management Stays United

Management has been quite firm in its view that a unified PepsiCo is a strong PepsiCo. Apart from the fact that splitting the company would cost PepsiCo as much as $1 billion in restructuring, the management has emphasized another fact. According to CEO Indra Nooyi, PepsiCo’s joint operations give it a level of insight into consumer tastes and preferences in food and drinks that perhaps no other company can boast of. ((“PepsiCo CEO: We’re Not Splitting the Company“, CNBC, Feb 2012))

This might be true, but understanding the consumers and actually meeting their needs are two different things. The company certainly seems to be bridging the gap with its ‘drinkify snacks’ strategy. Starting off with China seems a gamble given that the company’s foothold in the country isn’t really very firm. But China could also prove to be a good testing ground for such new products and strategies. If things work out, PepsiCo could effectively kill two birds with one stone – cracking the consumer code in China and finally proving to investors that PepsiCo is better off intact.

Where the company is really hoping the ‘drinkify’ strategy will help is in catching up with Coca-Cola in terms of soft drink sales, especially in emerging economies. By creating an instant connection in the minds of consumers between PepsiCo’s snacks and cola, the company is hoping some of the success it has had with snacks sales will rub off on its soda division.

Whether its strategy will be successful remains to be seen, but if the company is able to leverage this trend, we might see a revision in our projections for PepsiCo’s market share in soda sales in the near future. As you can see in the graph below, it’s only going one way right now.

Of course, irrespective of PepsiCo’s performance in the drinks segment, innovation can only help along the company’s strong performance in the snacks division – a key underlying factor in our above-market valuation of the company.

We have a price estimate of $79 for PepsiCo, which is about 15% higher than the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. “Pepsi to ‘drinkify’ snacks to grow beverage business“, MarketingMag.com, Dec 2012 [↩]