The Pepsi Bottling Group (NYSE:PBG) is the largest manufacturer, seller, and distributor of Pepsi-Cola beverages in the world. Though it is technically an independent bottling company, PBG is partially owned by PepsiCo (NYSE:PEP), and Pepsi brands accounted for 94% of PBG's 2006 unit sales.
Pepsi Bottling Group has been facing several challenges in recent years. PBG's largest operations are in its North American and Western European markets, which have recently been hit by declining consumption of carbonated soft drinks. Consumer preferences have been shifting away from carbonated soft drinks, which accounted for around two-thirds of PBG's 2006 units, to healthier alternatives. The prices of production inputs, especially aluminum and corn, have been rising as well, putting additional pressure on PBG's profits.
Despite these difficulties, PBG has performed relatively well. The Pepsi brands are very well known and enjoy significant brand loyalty. PBG's international markets have seen steady growth, helping to offset the sluggish domestic market. Also, PBG's performance is inherently tied to that of PEP, providing PBG with a certain degree of security in the highly competitive non-alcoholic beverage market.
On April 20, 2009, Pepsico (PEP) offered to acquire Pepsi Bottling Group in a stock and cash deal. Under the terms of the offer, Pepsi Bottling Group shareholders will receive $14.75 in cash and .283 Pepsico (PEP) shares per share of PBG. Pepsi Bottling Group rejected the offer after releasing higher than expected quarterly earnings. Pepsi Bottling Group enhanced its bargaining position through the $200 million purchase of Texas based Ab-Tex Beverage Ltd. On August 4, 2009, Pepsico (PEP) made a sweetened $36.50/share offer, which Pepsi Bottling Group accepted. The deal is expected to close in late 2009 or early 2010, and should provide the combined companies with $300 million in savings by 2012.. The spread between the acquisition price and Pepsi Bottling Group's current price represents the time value of money.
Pepsi Bottling Group was originally a division of PepsiCo but was spun off in 1999 to separate PEP's high-margin concentrate business from the capital-intensive bottling operations. Although they are two separate corporations, Pepsi still maintains a 41% ownership stake in PBG, ensuring a close business relationship.
PBG bottles, markets, and distributes non-alcoholic beverages, primarily the Pepsi trademark and other PEP brands. As a bottler, PBG purchases concentrated forms of its beverages from concentrate manufacturers. PBG then uses these concentrates to produce the finished beverages, which it then packages and distributes directly to retailers. PBG's largest concentrate provider by far is PepsiCo, and PBG is also the largest bottler of Pepsi products in the world, accounting for 60% of PepsiCo's domestic volume and about 40% of its global volume in 2006. As a result of this extremely close relationship, the two companies' performance is often highly correlated.
The Pepsi Bottling Group's operations are concentrated in the U.S. and Canada, with these two markets accounting for 78% of PBG's 2006 net revenues. PBG is also present in the European and Mexican non-alcoholic beverage markets, which accounted for 12% and 10% of 2006 revenues, respectively.
|Annual income data, in millions||2002||2003||2004||2005||2006||2007||2008|
1Q2009 In the first quarter of 2009 Pepsi Bottling Group posted revenues of $2.5 billion, a 5% decrease from 1Q2008 figures; net income almost doubled to $58 million. Revenue was negatively impacted by unfavorable foreign exchange fluctuations, while an increase in net pricing was canceled out by lower sales volumes. The increase in net income is attributable to new efficiencies across all of PBG's segments, as well as the company's ability to maintain costs while raising prices, contributing to a higher operating margin.
2Q2009 In the second quarter of 2009, Pepsi Bottling group posted revenues of $3.27 billion, a 7% decrease from 2Q2008 figures; net income increased 21% to $211 billion. Revenue was negatively impacted by a 4% decrease in physical case sales as well as a 3% revenue per case decrease. The fall in revenue per case was entirely due to unfavorable foreign currency translation; ignoring these exchange rate fluctuations, it would have grown by 5% during the quarter. The increase in net income was entirely due to a favorable tax audit settlement with both the US and Canadian governments, resulting in a tax benefit of $54 million. Ignoring this benefit, net income would have fallen 10% to $157 million.
As a bottling company, the Pepsi Bottling Group’s product line is determined by the offerings of its concentrate manufacturers. Currently, PBG’s portfolio is composed primarily of PepsiCo’s products, though 6% of its 2006 revenues came from the sale of non-Pepsi beverages. Although PBG’s products vary somewhat by region, many of its brands are similar across markets.
The drinks produced by PBG fall into one of three general categories: carbonated soft drinks (CSD), non-carbonated soft drinks (non-CSD), and water.
Carbonated soft drinks are the most common of the Pepsi Bottling Group’s offerings, accounting for 66% of the company’s total sales in 2006. Some of PBG’s notable brands of CSD include:
Sales for all non-carbonated soft drinks totaled 15% of Pepsi Bottling Group’s revenues in 2006. Some of PBG’s prominent non-CSD offerings are:
Water is usually placed in its own category due to its clear distinction from other non-carbonated soft drinks. PBG produces two brands of water, Aquafina and Propel fitness water, which accounted for around a combined 13% of the company's 2006 revenues. Aquafina is the top-selling brand of bottled water in the U.S. and has seen significant growth since its introduction in 2007.
Pepsi Bottling Group and PepsiCo have a very close professional relationship. PEP owns 41% of PBG's common stock and maintains around 47% of PBG's voting power. This close relationship with PepsiCo affects PBG in both positive and negative ways.
Pepsi Bottling Group and PepsiCo are bound by a master bottling agreement that governs the conditions of their business relationship. In the agreement, PepsiCo grants exclusive rights to PBG to market, produce, and sell PepsiCo products in certain geographic regions. PepsiCo also acts as PBG's agent for purchasing the raw materials needed for manufacturing. In exchange, PBG is obligated to purchase all of its concentrates from PEP at a non-negotiable price. PBG must also purchase all packaging and labeling materials from certain PEP-approved manufacturers.
The master agreement also includes a provision that discourages any individual or company from obtaining a significant percentage of PBG’s stock. If one entity comes to own 15% or more of PBG’s shares, PEP can cancel the master agreement. This clause effectively prevents hostile takeover attempts, but it also helps ensure PBG’s continued dependence on PEP.
Pepsi Bottling Group’s carbonated soft drinks account for around 66% of its revenues, making it susceptible to changes in demand for CSD.
Pepsi Bottling Group's profits are vulnerable to rising costs of production inputs. PBG uses several raw materials to produce and package its beverages, all of which can impact production costs and profit margins. Some of the most significant production inputs are:
Aluminum is used to make cans for packaging and represents around 15% of PBG's total cost of goods sold. In 2006, average aluminum prices were up nearly 40% for the year.
PBG uses high-fructose corn syrup, a corn derivative, to sweeten its non-diet, full-calorie drinks. High-fructose corn syrup accounts for 10% of PBG's cost of goods sold. In 2006, corn prices were up 79% over 2005. PBG, however, acquires its high-fructose corn syrup through PepsiCo's global procurement division, which can help negotiate lower prices.
PBG makes all of its plastic bottles from PET resin. Recently, plastic bottles have been more popular than aluminum cans, with PET representing 20% of PBG's cost of goods sold. In 2006, PET prices rose to a high of around 88 cents per pound but have since been declining.
Concentrates and syrups form the base of all PBG's beverage products. PepsiCo has maintained a low concentrate cost increase of around 2% annually, helping to mitigate the impact of inflated commodity prices on PBG's production costs. In 2007, however, PEP plans to increase concentrate costs by 3.7%.
Pepsi Bottling Group’s main competitors are the Coca-Cola Company (NYSE:KO) and its bottling affiliates. The most important are KO’s top three bottling companies: Coca-Cola Enterprises (NYSE:CCE), Coca Cola Femsa S.A.B. de C.V. (KOF), and Coca-Cola Hellenic Bottling Company S.A. (NYSE:CCH). In 2006, Pepsi had a 31.2% share by volume of the U.S. non-alcoholic beverage market, second to Coca-Cola's 42.9%. The third-largest company in the domestic market is London-based Cadbury Schweppes (NYSE:CSG), which accounted for 17.6% of the 2006 U.S. market share.
Declining demand and high cost pressures have taken their toll on the domestic non-alcoholic beverage market in recent years. Compared to KO's largest bottler CCE, however, PBG's operating margins have remained relatively high.
|Operating margins, annual||2002||2003||2004||2005||2006|
|Pepsi Bottling Group||9.74%||9.32%||8.94%||8.61%||8.19%|