PepsiCo is one of the world’s largest suppliers of foods and beverages in the world, with a global footprint spanning more than 200 countries. In packaged foods, the company owns and operates some of the most recognizable brands in the world such as Frito-Lay’s and Quaker. In the beverage segment, the company is most famous for its flagship soda drink Pepsi. Apart from Pepsi, the company also own brands such as Gatorade and Tropicana in the beverage segment.
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In 2011, PepsiCo earned around $66 billion in revenues, up from around $43 billion in 2009. A major reason for this jump in top-line was the acquisition of its bottling operations in North America, which was earlier being handled by partners Pepsi Bottling Group and PepsiAmericas. This gives it a greater share of revenues in the bottled beverage value chain.
The company’s margins declined from around 23% in 2009 to 21% in 2010, mainly due to restructuring of its operations following the bottling facility acquisition and increased spending on marketing and advertising worldwide.
What are the key sources of value for the company and the underlying market trends?
The Food Division
PepsiCo’s core strength lies in its food division, which largely consists of packaged snacks sold under the Frito-Lay’s banner. While the company earned around 48% of its total revenues from packaged foods in 2011, the segment contributed nearly 60% of the company’s total EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), displaying its high profitability. We estimate the company derives 60% of its stock value from the food division.
PepsiCo dominates the market for packaged snacks, especially in developed, western economies. With brands such as Cheetos, Doritos and Lay’s potato chips under belt, Frito-Lay’s commands a market share of nearly 40% in the US.
1. The company’s strong position in North America and Western Europe is primarily because of its wide portfolio of packaged foods available at a variety of price points. The company’s ability to splash out on advertising and marketing also helps it maintain distance from smaller competitors.
2. With consumer demand stagnating in developed economies, the company is increasingly turning to emerging economies such as China and India. But it is facing stiff competition from local players in these geographies who have a better understanding of local tastes and preferences. In order to improve its appeal, the company is stepping up its R&D efforts. For example, the company set up a R&D facility in Shanghai in 2012 to understand the tastes of the Chinese consumer better. This is the company’s largest R&D facility outside the US.
Going forward, we expect PepsiCo to maintain its lead in the packaged foods market in North America and Europe. In emerging economies, we expect its efforts to localize product flavors to pay off in the long run. With the marketing machinery that PepsiCo possesses, it should be able to displace smaller, local competitors quite easily in the next few years.
The Beverage Division
Unlike PepsiCo’s food division, which is the dominant force in developed markets, the company’s beverage segment trails arch rival Coca-Cola across most geographies. As a result, the company doesn’t quite have as much pricing power in beverages as it does in snacks. This leads to generally lower margins for beverage products. In 2011, beverages contributed nearly 52% of total company revenues, but EBITDA contribution stood at only 40%.
1. In developed economies such as North America and Western Europe, the consumption of carbonated soft-drinks is declining at a steady pace due to health concerns and pressures from health advocacy groups.
In the face of increasing competition from Coca-Cola and Dr Pepper Snapple, PepsiCo is investing in large-scale marketing and advertising to boost sales of its flagship drink, Pepsi. In 2012, the company increased its marketing spend by around $600 million. This included a sponsorship agreement with NFL and pop stars such as Nicki Minaj and Beyonce as part of the ‘Live For Now’ campaign.
Despite these attempts at reviving the Pepsi brand, we expect the company to continue losing market share in CSDs in North America and Europe. This is primarily because the company’s strong focus on expanding its snacks business in emerging economies is giving more space for competitors such as Coca-Cola and Dr Pepper Snapple to maneuver. Both these companies have increased their market share in North America and Europe in recent years at the cost of Pepsi. We expect the trend to continue in the future.
2. In emerging markets, Coca-Cola already has a pretty strong grip on CSDs in regions such as China and Latin America. It will be difficult for Pepsi to push its rivals out as consumers tend to be quite loyal to their favorite drinks. Nonetheless, PepsiCo is ramping up its production capacity in China with a large-scale partnership with Tingyi, one of the largest beverage companies in the country. PepsiCo will also need to step up its marketing and advertising spend in emerging economies to see any traction in CSD sales.
3. The decline in demand for carbonated sodas (CSDs) in developed economies is in turn fueling the demand for healthier beverages such as juices, teas and sports drinks. Pepsi’s Tropicana range of juices has been losing out to Coca-Cola’s minute maid in terms of volumes in recent years. This is primarily because of Coca-Cola’s strong focus on innovation and introducing products at diverse price points.
Pepsi’s ‘Gatorade’ range of sports drinks is a bright spot for the company in the beverage segment, with the company seeing strong sales in recent years, thanks to effective marketing and product innovation. The company has launched a new series of Gatorade drinks called the G series, and the product seems to be performing quite well. Gatorade has a leading market share in the sports drinks category, ahead of Coca-Cola’s Powerade.
4. Non-carbonated beverages such as juices also provide a good opportunity for Pepsi in emerging economies. However, this market is largely dominated by local players in countries like China and India. We do not expect Pepsi to witness any major traction in the near future because of intense competition.
We have a price estimate of $79 for PepsiCo, which is about 15% higher than the current market price.