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PEP AT A GLANCE

P/E ► 18.1 AVG EV/EBITDA ► 12.1 AVG ROA ► 14.7% HIGH ROE ► 33.2% HIGH Debt to Equity ► 1.50 AVG Current Ratio ► 1.34 AVG Interest Coverage Ratio ► 18.3 AVG

 

 

 

 

 

 

PepsiCo Inc. (NYSE:PEP) is a global manufacturer, distributor, and marketer of food and beverages, owning many well-known brands including Pepsi, Frito-Lay, Tropicana, Gatorade, and Quaker Oats.^[1] PepsiCo operates in over 200 countries, with its largest markets in North America and the United Kingdom.^[2]

Unlike its major competitor, the Coca-Cola Company (KO), the majority of PepsiCo's revenues do not come from carbonated soft drinks.^[3] In fact, beverages account for less than 50% of total revenue.^[3] Additionally, over 60% of PepsiCo's beverage sales come from its key noncarbonated brands like Gatorade and Tropicana.^[4] PepsiCo's diverse portfolio can mitigate the impact of poor conditions in any one of its markets. Strong demand growth in international markets -- the company serves 86% of the world's population and international sales account for 48% of revenue -- is helping to offset a sluggish domestic market and provided the company with opportunities for continued expansion.^{[5] [6]}

PepsiCo is highly exposed to raw materials costs. Prices for the most important input materials, aluminum, PET plastic, corn, sugar, and juice concentrates fluctuate widely. For example, aluminum prices have fallen more than 60% from their 2008 highs of $1.50/pound to less than $0.65/pound.^[7] PepsiCo should benefit from lower input prices after the collapse of the commodities super spike of 2008.

On April 20, 2009, PepsiCo made an offer to acquire its two largest bottlers, Pepsi Bottling Group (PBG) and Whitman (PAS), for $6 billion in a combined cash and stock deal. The deal was turned down, forcing PepsiCo to make a sweetened $7.8 billion offer on August 4, 2009. PepsiCo hopes to streamline manufacturing and distribution through the acquisitions, allowing it to bring new products to market more quickly and efficiently. The company expects to gain full control of 80% of its North American market and increase pre-tax profit by $300 million, increasing eps by $.15.^[8] The deal is expected to close in late 2009 or early 2010, adding $4 billion in debt to PepsiCo's balance sheet. According to PepsiCo CEO Indra Nooyi, the acquisition is necessary to consolidate profit as there is not enough total profit in the North American beverage industry to support investments in several different companies.^[9]

Company Overview

PepsiCo is the largest snack and non-alcoholic drink producer in the United States, with 39% and 25% of the respective market shares.^[10] Although the carbonated soft drink market in the US has gradually declined since the mid-2000s, PepsiCo has been able to grow revenues and net income through product diversification and international expansion. In 2008, the company posted revenues of $43.3 billion, a 9.6% increase from 2007; net income fell by 9% to $5.1 billion.^[11] The increase in revenues was primarily driven by higher sales volumes in the key European and Asian markets as well as company wide price increases.^[12] The fall in net income was attributable to two reasons. First, PepsiCo recognized a $346 million mark-to-market loss on derivatives used to hedge its commodity exposure.^[13] Next, the company incurred restructuring costs of $543 million in relation to its Productivity for Growth program.^[14] PepsiCo expects to record another $30-60 million charge in 2009 to complete the program, which will close six plants in an effort to streamline PepsiCo's global supply chain.^[14]

Quarterly Earnings

1Q09 In the first quarter of 2009, PepsiCo posted revenues of $8.263 billion, a 1% decrease from 1Q2008 figures; net income fell less than 1% to $1.135 billion.^[15] Although net pricing across PepsiCo's product line increased by 7% during the quarter, the company was negatively impacted by a 7% foreign exchange loss due to the strengthening US dollar, as well as a 2% net decrease in sales volume.^[16]

Contents 1 Company Overview 1.1 Quarterly Earnings 1.2 Bottlers 1.3 Operating Segments 2 Trends & Forces 2.1 PepsiCo Must Survive a US Slowdown While Capturing International Growth 2.2 Commodity Costs are Pressuring Margins 2.2.1 Pepsi Must Face a Declining Demand for Carbonated Soft Drinks 2.2.2 The Dollar Affects International Performance 3 Competition 3.1 Beverages 3.2 Snacks and Convenient Foods 3.3 Coke vs. Pepsi 3.3.1 Global Footprint 3.3.2 Diversified Product Offering 4 References

2Q09 In the second quarter of 2009, PepsiCo posted revenues of $10.592 billion, a 3% decrease from 2Q08 figures; net income fell less than 1% to $1.66 billion.^[17] PepsiCo's volumes remained roughly constant between the quarters, with snack gaining 1% and beverages losing 1%. The decrease in net revenues was due to a weakening of the company's US beverage operations, which decreased by 9%, in addition to the strengthening dollar, which adversely affected revenues by 8.5%. Ignoring these changes, revenues would have grown by 5.5%, driven by gains in the the Latin America Foods and Asia/Middle East/Africa divisions. Net income remained roughly constant as input costs fell in line with net revenues. Ignoring currency fluctuations, Earnings Per Share (EPS) would have grown by 8%.^[17]

Bottlers

*Note - Pepsi's acquisition of Pepsi Bottling Group (PBG) and PepsiAmericas (PAS) is expected to be completed in the 4Q2009 or 1Q2010

PepsiCo's beverage division manufactures concentrated syrup forms for all of Pepsi's beverage brands. PEP sells these concentrates to bottlers for production, packaging, and distribution of the final products. PepsiCo grants bottlers the use of Pepsi trademarks and other brand rights within certain geographic regions.

In August 2009, Pepsi made a $7 billion offer to acquire Pepsi Bottling Group (PBG) and PepsiAmericas (PAS). As the US carbonated beverage market shrinks - from 60% of all nonalcoholic beverages in 1999 to 35% in 2009 - PepsiCo hopes to consolidate the earnings of the three companies for shareholders.^[8] Additionally, PepsiCo believes the acquisitions will streamline company-wide distribution through economies of scales.

Three companies distribute 60% of PepsiCo's North American beverage volume:^[18]

• The Pepsi Bottling Group (PBG) is the largest of PepsiCo's bottlers. PepsiCo has a 33% stake in Pepsi Bottling Group (PBG), and claims its share of income under the equity method of accounting.^[19]
• PepsiAmericas (PAS) is the second-largest bottler in the Pepsi system. PepsiCo has a 43% stake in PepsiAmericas (PAS), and claims its share of income under the equity method of accounting.^[20]
• Pepsi Bottling Ventures is the third-largest domestic bottling company within the Pepsi system. The company was formed in 1999 when five of Pepsi’s bottling companies consolidated to form PBV.

Operating Segments

PepsiCo operates in six divisions:

• Frito-Lay North America (29% of Revenue, 43% of Operating Income)^[21] manufactures, markets and sells branded snacks. Popular products include Lay's Potato Chips, Doritos Tortilla Chips, Cheetos, Rold Gold Pretzels, and SunChips.^[1]

• Quaker Foods North America (4% of Revenue, 8% of Operating Income)^[21] manufactures, markets and sells cereals, rice, pasta and other branded products. Popular products include Quaker Oatmeal, Aunt Jemima mixes and syrups, Cap n' Crunch cereal, Rice-A-Roni, and Life cereal.^[1]

• Latin America Foods (14% of Revenue, 13% of Operating Income)^[21] manufactures, markets and sells a number of leading salty and sweet snack brands. Popular products include Gamesa, Doritos, Cheetos, and Ruffles.^[3]

• PepsiCo Americas Beverages (25% of Revenue, 29% of Operating Income)^[21] manufactures, markets and sells beverage concentrates, fountain syrups and finished goods, under various beverage brands. Popular products include Pepsi, Mountain Dew, Gatorade, Tropicana, and Izze.^[3]

• United Kingdom & Europe (15% of Revenue, 10% of Operating Income)^[21] manufactures, markets and sells a number of leading salty and sweet snack brands. Popular products include Lay's, Walker's, Doritos, and Cheetos.^[3]

• Middle East, Africa, and Asia (13% of Revenue, 8% of Operating Income)^[21] manufactures, markets and sells a number of leading salty and sweet snack brands. Popular products include Lay's, Smith's, Doritos, and Cheetos.^[22]

Trends & Forces

PepsiCo Must Survive a US Slowdown While Capturing International Growth

Soaring food and energy prices^[23], the housing slump^[24] and a weakening job market^[25] are putting the breaks on consumer spending in North America, even in the typically recession proof drinks and snacks market.

Emerging markets such as China, India, Eastern Europe and Latin America present strong growth opportunities for Pepsico. In fact, rapid volume growth in these emerging markets have offset the worst of the damage in the company's core domestic market over the course of 2008. Pepsico has sought to expand its presence is fast growing emerging markets through several acquisitions. In Feburary, 2007, Pepsico offered to purchase Lucky snacks of Brazil in an effort to expand its foot print in South America and the attractive Brazilian market. Pepsi also followed it's June, 2007 acquisition of Ukrainian juice maker Sandora with the $1.4B purchase of 75% of Russian juice maker Lebedyansky to tap into fast growing eastern European and Russian markets^[26]. PepsiCo plans to continue its expansion into Russian markets with a partnership with Pepsi Bottling Group (PBG) to invest $1 billion in the country by 2012.^[17] The company's most recent efforts involve the distribution and installation of coolers throughout India. By tying the increased volume of cooler space to PepsiCo products, the company hopes to grow revenues in this emerging market.

Commodity Costs are Pressuring Margins

PepsiCo's profitability can be affected directly and indirectly by the costs of various production inputs. PEP is responsible for purchasing the raw materials used to make its products in all its markets and also acts as an agent for the purchase of its bottlers' raw materials. Some of the raw materials used by PEP include grains such as corn, wheat flour, oats and rice; fruit and vegetable products like oranges, potatoes, and juice concentrates; sugar; and vegetable and essential oils. For example, aluminum prices have fallen more than 60% from their 2008 highs of $1.50/pound to less than $0.65/pound.^[7] Changes in the prices of such raw materials could impact total production costs and the company’s profit margins. Changes in bottlers' production input costs can also indirectly impact PEP's profits. If a bottler's raw materials become more expensive, it might pass on the increase to customers, which could lead to a loss of market share as customers switch to more affordable alternatives. The primary raw materials used by bottlers are high fructose corn syrup, which is used as a sweetener, aluminum, used to make cans, and PET Resin, used for plastic bottles.

Pepsi Must Face a Declining Demand for Carbonated Soft Drinks

Consumer demand for CSD has been negatively affected by concerns about health and wellness. Since 1999, carbonated soft drinks have dropped from 60% to 35% of total US beverage volume.^[8] Rising health and wellness concerns can be attributed to increasing concern for obesity as well as education campaigns on the part of the FDA as well as non-profit groups. Public campaigns to ban sales of soft drinks and fatty snacks in schools have also negatively impacted demand for sugary sodas. These factors have driven a shift in consumption away from CSD to healthier alternatives, such as tea, juices, and water. Even within the CSD segment, consumers have been moving away from the sugared drinks, opting instead for diet beverages, which do not generally contain any sugar or calories. In response to this shift in consumer demand, PEP has increased its development of both diet CSD and non-CSD beverages. With its popular Tropicana and Gatorade brands, PepsiCo is much better situated than Coca-Cola Company (KO) to react to these changing trends.

The Dollar Affects International Performance

Changes in the strength of the dollar compared to foreign currency could impact the company by decreasing both costs and revenue in dollars. As the strength of the dollar increases, all sales made in foreign currency end up being worth less because the amount of US dollars the company gets per sale decreases. On the other hand the cost of foreign inputs (food and other commodities that go into PepsiCo products) sold in foreign currencies would decrease with the strengthening dollar. Since over half of PepsiCo's sales are in international markets, the increasing value of the dollar could be a significant factor driving revenues down overseas. Specifically the company primarily deals with the British Pound, Euro, Australian dollar, and Canadian dollar. Between July and December 2008, the dollar regained nearly all its 2007 losses against foreign currencies, and has continued this trend through 2009.^[17]

Competition

Beverages

In the domestic beverage market, the Coca-Cola Company (KO) is PepsiCo's main competitor. In 2008, Coca-Cola had a 23% share of the U.S. non-alcoholic beverage volume, while PEP held a 25% share. Coca-Cola Company (KO) has a higher worldwide share of carbonated soda beverages, but PepsiCo has a more diverse product line and leads the industry in non-carbonated soft drink innovations.^[29] PepsiCo's revenues are also substantially higher than Coca-Cola's, due to PepsiCo's snack and convenient foods business, a market in which KO does not participate. PepsiCo's presence in the snack and convenient food industries, as well as its industry-leading innovations in the non-carbonated soft drink segment, gives it a somewhat more balanced portfolio than Coca-Cola and provides the company with some protection against further declining demand for CSD.

Snacks and Convenient Foods

PepsiCo's Frito-Lay and Quaker brands compete in various parts of the larger food industry. Its snack foods manufactured by the Frito-Lay segment hold a commanding share of the U.S. market, accounting for around 39% of domestic snack food sales in 2006. PepsiCo's main competitor in the food market overall is Kraft Foods (KFT). Kraft's products include snacks, cheese, diary, and cereal products, which puts it in competition both with Frito-Lay and Quaker products. Much like the Coca-Cola Company (KO), Kraft does not participate in both the food and soft drink markets, giving PEP the advantage of having a more diverse offering of products.

Coke vs. Pepsi

For decades now, Coke and Pepsi have battled for our hearts and minds... but what about our capital? Which company will add the best flavor to your investment portfolio? Although both companies share powerful brand names and global franchises, there are two important distinctions between Pepsico and Coca-Cola that any investor should consider before choosing between these comestible titans:

Global Footprint

When it comes to international presence, Coca-Cola easily trumps Pepsico. In 2008, Coca-Cola generated around 75% of its revenue overseas compared to 48% of revenue for Pepsico.^[30][31] Coca-Cola's impressive global footprint puts it in a better position to benefit from strong growth across the globe, particularly in the developing world. Furthermore, because Coke generates so much of its revenue abroad, it stands to benefit greatly from the continuing weakening of the dollar as sales denominated in foreign currencies are suddenly worth more dollars back home. At the same time, Pepsico's heavy dependence on North America makes it much more susceptible to a slowing US economy.

Diversified Product Offering

Another important distinction between the two companies is their product offering. While KO is essentially a one-product company that focuses on beverages, Pepsico has a much broader product base that includes beverages, foods and snacks. Coca-Cola's heavy dependence on beverages, particularly carbonated beverages, makes it more susceptible than Pepsico to a growing aversion to soda which is perceived as fattening and unhealthy. On the other hand, Pepsico's extensive portfolio of beverages, foods and snacks puts it in a better position from the trend to healthier eating.

References

1. ↑ ^{1.0 1.1 1.2} PEP 2008 10-K pg. 2  
2. ↑ PEP 2008 10-K pg. 1  
3. ↑ ^{3.0 3.1 3.2 3.3 3.4} PEP 2008 10-K pg. 3  
4. ↑ Pepsi's bottler bid: Changing the channel again.
5. ↑ PepsiCo Interactive 2008 Annual Report.
6. ↑ PEP 2008 10-K pg. 106  
7. ↑ ^{7.0 7.1} Aluminum Price Charts.
8. ↑ ^{8.0 8.1 8.2} PepsiCo to buy Pepsi Bottling, PepsiAmericas for $7.8 billion.
9. ↑ PepsiCo to buy bottlers for $7.8 bln; shares up.
10. ↑ ^{10.0 10.1} PEP 2008 10-K pg. 2-4  
11. ↑
12. ↑ PEP 2008 10-K pg. 54  
13. ↑ PEP 2008 10-K pg. 48  
14. ↑ ^{14.0 14.1} PEP 2008 10-K pg. 49  
15. ↑ PEP 2009 10-Q pg. 3  
16. ↑ PEP 2009 10-Q pg. 26  
17. ↑ ^{17.0 17.1 17.2 17.3} PepsiCo's Strong, Diversified Portfolio and Growth Strategy Deliver Solid Second-Quarter Results; Company Reaffirms Full-Year Guidance.
18. ↑ PEP 2008 10-K pg. 33  
19. ↑ PEP 2008 10-K pg. 100  
20. ↑ PEP 2008 10-K pg. 101  
21. ↑ ^{21.0 21.1 21.2 21.3 21.4 21.5} PEP 2008 10-K pg. 77  
22. ↑ PEP 2008 10-K pg. 4  
23. ↑ The Boston Globe- Surging costs of groceries hit home
24. ↑ Bloomberg Case-Shiller Index Falls
25. ↑ NYTimes Unemployment Rising
26. ↑ PepsiCo, Pepsi Bottling Buy 75% of Lebedyansky Juice
27. ↑ PET Price Chart.
28. ↑ ^{28.0 28.1} PEP 2008 10-K pg. 7  
29. ↑ PEP 2008 10-K pg. 6  
30. ↑ PEP 2008 10-K pg. 37  
31. ↑ KO 2008 10-K pg. 71