US-based food and beverage producer PepsiCo is split into three major divisions: PepsiCo Americas Beverages, PepsiCo Americas Foods (PAF) and PepsiCo International. For most of its soft drink brands, Pepsi North American Beverages (PNAB) manufactures and sells concentrate to licensed bottlers, who sell the branded products to independent distributors and retailers, while providing marketing, promotional and sales support. The company's brands include Pepsi, Mountain Dew, Gatorade, Tropicana Pure Premium and Aquafina. PAF is PepsiCo's food and snack business in North and South America. Its portfolio of businesses includes Frito-Lay North America, Quaker Foods & Snacks, Sabritas, Gamesa, and Latin America Foods. PepsiCo International produces and distributes this portfolio of brands around the world.
Well-established reputation and immense international brand appeal ensures an upward growth trajectory.
Well-built portfolio of snacks and a low debt level relative to its peers provides a lucrative platform for PepsiCo to extend its reach into emerging markets.
Strong international presence with good exposure to many EMs.
Increasing health consciousness will impact on many of PepsiCo's core products.
High exposure to carbonates sector, which has seen sluggish growth in recent years.
Heavy exposure to North America remains a drag on its fiscal health.
Underperforming beverages arm arguably limits the company's growth potential.
High growth opportunities in EMs can offset forecast demand weakness in developed economies.
Has the definite opportunity to increase its snacks portfolio and become a global leader in this category.
Splitting the company will arguably create two better positioned companies with more clear directions.
The option to increase equity exposure in Chinese FMCG company Tingyi could represent an important and profitable investment.
EMs slowdown could hurt PepsiCo's revenue growth in the short term.
Governments could act more authoritatively on unhealthy foods, which would damage PepsiCo's sales and/or income.
Significant investments in EMs could be misplaced and not be used to potential.
PepsiCo operates through three main divisions: Americas Food, Americas Beverages and International, which is subdivided by region. Over the past six months, in line with its international diversification strategy, the company has committed significant investment to a variety of emerging market (EM) regions. These include a US$5.5bn investment to go into India by 2020, announced in November 2013, and a further US$5bn to go into Mexico over the next five years, announced in January 2014. In our view, such strong pledges to these countries are necessary for PepsiCo to grow its business and maintain its dynamism.
Often in the background, calls for PepsiCo to split along its snack and soft drink lines have intensified recently, yet have been met with resilient opposition from the company's management. CEO Indra Nooyi has argued that integration is best for the company, as 'snack and beverage occasions are typically planned together, and the products are both purchased and consumed together'. While this may be the case, BMI believes that the benefits of the increased integration are likely to be only small, while the benefits from a full demerger of the company into two separate businesses could potentially be great.
However, we note that the suggestion from Trian Fund Management's activist investor Nelson Peltz that a newly formed snacks business should merge with Kraft spinoff Mondelez International is unlikely. PepsiCo is still highly indebted following the acquisition of its two largest North American bottlers ( Pepsi Bottling Group and PepsiAmericas), completed in 2010. Furthermore, we believe that Mondelez will be somewhat reluctant to do a deal, considering the company only split from Kraft in 2012.
Pressure on the firm has built up largely due to the underperformance of PepsiCo's North American soft drinks arm, which is still a crucial source of earnings but has been hit by a move away from carbonated beverages in the region, and market share gains by The Coca-Cola Company (TCCC). PepsiCo attempted to aid profitability of its beverages arm with the acquisition of its North American bottling operations. However, such a deal has so far failed to have a significant impact on topline results. Prior to the acquisitions, revenue from the Americas Beverages arm fell by 1.4% year-on-year (y-o-y) and 7.5% y-o-y in 2008 and 2009 respectively. Though revenue grew by 9.9% y-o-y the year after the acquisitions in 2011, 2012 saw a fall in revenue of 4.5% y-o-y and of 10.3% y-o-y in operating income. The segment looks as if it will record generally flat revenue growth in 2013, with a marginal increase in profitability.
Revenue Growth & Operating Margin By Segment
| || FY 2008 || FY 2009 || FY 2010 || FY 2011 || FY 2012 |
| PepsiCo Americas Food || || || || || |
| Revenue Growth || 10.8 || 2.5 || 3.5 || 7.4 || 3.7 |
| Operating Margin || 21.86% || 23.02% || 23.77% || 23.76% || 22.51% |
| PepsiCo Americas Beverages || || || || || |
| Revenue Growth || -1.4 || -7.5 || 101.7 || 9.9 || -4.5 |
| Operating Margin || 18.52% || 21.47% || 13.61% || 14.60% || 13.72% |
| PepsiCo International || || || || || |
| Revenue Growth || 19.3 || 2.5 || 29.2 || 31.8 || -4.1 |
| Operating Margin || 12.31% || 13.39% || 11.09% || 10.01% || 10.34% |
| Source: Bloomberg |
A more positive move by PepsiCo has been its push into high-growth EMs such as China, India, Russia and Mexico. Despite this expansion abroad, PepsiCo remains over reliant on the US. Though the US economic recovery is now well and truly under way, we believe that demand in soft drinks will follow a general long-term declining trend, while industry snacks growth will be subdued. Such a performance represents one of our core long-term views that rising health consciousness, predominantly in the developed world, will negatively impact on sales of foods that are perceived to be unhealthy.
| Poor Outlook For Unhealthy Foods |
|US - Per Capita Carbonated Soft Drink (RHS) and Confectionary Sales (LHS)|
Despite greater expansion into EMs, PepsiCo continues to earmark the lion's share of its capital for its American operations. Furthermore, despite the company's Middle East, Africa and Asia (MEAA) operations recording the largest sales volume growth over the past five years, capital expenditure (capex) within the region fell to its lowest level in four years in FY2012.
| Consistently High Growth In MEAA, Yet Capex Dropped In FY2012 |
|PepsiCo - Sales Volume By Region (LHS, % chg y-o-y) & Capital Expenditure By Region (RHS, US$mn)|
However, recent investments from PepsiCo indicate a strong strategic position. In particular, we see great potential in the company's Chinese and Indian operations. As is relatively common with FMCG multinationals entering into India, PepsiCo has invested significantly into all stages of its business, from agricultural production right down to marketing and the point of sales. Though initially expensive, such a move could give PepsiCo a significant edge over its opponents. By leveraging its significant financial position, PepsiCo has the ability to achieve a good deal of vertical integration that could end up being much more efficient than its rivals in the country. By 2020, the company hopes to double its current production capabilities. Such a move from PepsiCo comes following rival Coca-Cola's similar US$5bn investment in 2012.
PepsiCo has used domestic partners in Asia to good effect. Along with its partnership with Indian giant Tata Tea, established in 2010, the company has franchised out its business in China to the country's largest food and beverage company, Tingyi Holding Corporation (Tingyi). PepsiCo has been able to make use of Tingyi's large distribution network across China, enabling the company to penetrate deeper into the country. Without this partnership, it is likely that Coca-Cola would have consolidated its dominant position over PepsiCo within the country. Now, however, the Tingyi-Pepsi partnership has reduced Coca-Cola's market share to 16%, down from 16.6% five years ago. Through the agreement in 2012, PepsiCo holds a 5% equity stake in Tingyi's holding company, Tingyi-Asahi Beverages Holding Co. Ltd (TAB). PepsiCo also holds an option to increase its holding in TAB to 20% by 2015. In our view, PepsiCo should exercise this option, given our belief that Tingyi will deliver consistent sales and income growth over the mid- to long term. We hold this view primarily due to Tingyi's superior production and distribution network within China, which surpasses that of its rivals Hangzhou Wahaha, Uni-President and TCCC's operations within the country (see 'Wahaha The Market Leader For Now', February 4 2014).
| Tingyi Has The Largest Manufacturing Presence In Chinese Soft Drinks |
|Selected Companies - Number Of Chinese Production Facilities|
PepsiCo's strategies within China and India are, in our view, sensible moves. It was unlikely that PepsiCo would be willing to establish a distribution network within China in the same manner that TCCC has, and has chosen a practicable company in Tingyi. Similarly, its investment in India demonstrates a commitment and a willingness to mitigate TCCC's brand advantage, which has arguably been one of PepsiCo's major banes in operations in other markets. Both firms continue to match each other blow for blow in terms of product development, capacity increases and price cuts, and this has prevented PepsiCo from cutting into the healthy market share lead already possessed by TCCC.
We have long argued that we believe PepsiCo's strengths lie within creating the 'Coke of snacks'. Though management has been reluctant to split the company and acquisitions in recent years, and has previously hinted that this is not the line it will take, its recent commitment to Mexico marks a possible break from such a strategy. In January, the company announced it would invest US$5bn into the country over the next five years, despite the government's recent hikes on unhealthy food and soft drinks. Given Coca-Cola's dominance in the country (on average Mexicans drink almost twice the amount of TCCC products compared with consumers in the US), we believe that PepsiCo will instead concentrate on its snacks business in the country. Indeed, we believe that Mexico, despite its government's action, will be one of the bright spots in global food and drink over the decade. In our view, the country's well-developed mass grocery retail sector will help drive sales of packaged foods.
| MGR To Drive Industry Value |
|Mexico - Food Consumption & MGR Sales (MXNbn)|
We maintain our belief that PepsiCo would benefit from greater concentration on its snacks business, and it could do this in Mexico, before replicating the move across other markets. We believe that this is where PepsiCo holds a significant advantage over TCCC, especially after some years of declining per capita sales of carbonated soft drinks within the US. In the past, we have said that if a PepsiCo split were to happen, than international brewer Anheuser- Busch Inbev (AB Inbev) could take over the drinks operations. We believe that this would be a viable move for two reasons. Firstly, an increase in size of the smaller branch would be required in order to continue competing with TCCC, and secondly PepsiCo and AB Inbev already operate together through Ambev in Latin America.
Looking at the relatively short term, we believe that PepsiCo, like many other FMCG companies, will experience stunted revenue growth due to the emerging markets slowdown currently taking place. An economic slowdown, evident in EMs such as Brazil and Turkey, will lead to lower than potential food consumption. Significant depreciations in EM currencies against the US dollar will also adversely affect PepsiCo, in both its exports to EMs as well as on its income statement. However, we believe that while difficulties experienced across many EM countries are significant, the long-term trajectory of such countries remains the same.
From a valuations point of view, we believe that PepsiCo is held back by its underperforming beverages arm. Of the companies listed below, PepsiCo has the best five-year growth rate and earnings per share (EPS). As well as this, the company has a fairly low debt level, and a profit margin where one would expect it to lie: between TCCC (core beverage company) and Kellogg and Mondelez (geared up more towards snacks). Despite this, as well as its significant recent investments into Mexico and India, PepsiCo trades at a discount to many of its peers.
Selected Companies: Selected Financial Metrics
| || Trailing P/E Ratio || Total Debt/ EBITDA || Revenue: 5 Year Geometric Growth || EPS || Profit Margin (12 month trailing) |
| PepsiCo || 18.4 || 2.4 || 9.6 || 4.3 || 10.1 |
| TCCC || 18.6 || 3.0 || 8.8 || 2.0 || 18.5 |
| Dr Pepper Snapple Group || 15.8 || 1.9 || 0.7 || 3.1 || 10.6 |
| Kellogg || 17.5 || 3.6 || 2.6 || 2.6 || 6.4 |
| Mondelez International || 21.6 || 3.9 || -1.4 || 1.5 || 7.8 |
| Source: Bloomberg |
At the time of writing, PepsiCo is at an interesting place from a technical point of view. The stock has just come off of year-long support, at a time when many other FMCG companies are underperforming relative to their respective indices. Our global markets team has argued that following a successful 2012 and first half of 2013, consumer staples will likely underperform the market. This is because their status as quasi-safe havens has dissipated, as growth in developed economies has picked up pace.
| Hitting Support |
|PepsiCo - Share Price (US$)|