Food and Beverage Giants Face Shareholder Activism

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Mondelez International (NASDAQ: MDLZ) and PepsiCo (NYSE: PEP) have two significant themes unfolding. The first is emerging markets, where incomes are rising and we are seeing an emerging middle class that wants the same treats as their Western counterparts. The second is activist investors looking to create value for shareholders.

A delicious world

Mondelez International is a global snack-foods company that gets approximately 80% of its revenue from outside North America. Its products are sold under the Oreo, Nabisco, Ritz, Cadbury, Trident, Jacobs and many other brands.

In the second quarter of this year, revenue rose 0.8% to $8.6 billion. Its strongest brands posted double-digit sales increases. Revenue from emerging markets was up 9.7% and were lead by double-digit increases in Brazil, Russia, India and China.

The biggest news to come out of the quarter for shareholders was the return of capital to shareholders. Mondelez International increased its share repurchase program from $1.2 billion to $6 billion into 2016. The company also increased the quarterly dividend by 8% to $0.14 per share.

The other big news for shareholders is that activist Nelson Peltz is circling both Mondelez International and snack-food giant PepsiCo. He has taken a stake in both companies and wants PepsiCo to purchase Mondelez International. So far PepsiCo has rebuffed his proposal, but Peltz is not known for backing down, especially when he has over $2 billion invested between both companies.

Going forward, what Mondelez International needs to focus on is improving its margins. Both its gross margin and operating margins are lower than that of PepsiCo and Nestle (ADR) (NASDAQOTH: NSRGY). Mondelez International is working to increase margins by investing $350 million in a state-of-the-art biscuit factory in Mexico, where costs are low. The company is also working to improve its supply chains in emerging markets. By improving its margins, the company will see increased profits and less pressure from activists pushing for a change at the company.

More than just Pepsi

While PepsiCo is best-known for its Pepsi products, its snack foods business actually contributes almost 60% of its profits. In PepsiCo's second quarter, earnings per share increased 17% to $1.31 and organic revenues grew 4.2%. In the U.S., organic growth for the foods division increased 6%. Both gross margins and operating margins increased by 100 basis points. The two fastest-growing segments for PepsiCo were Latin America and the Asia, Middle East and Africa region.

This year, PepsiCo plans to return approximately $6.4 billion to shareholders. The company will pay dividends of approximately $3.4 billion and repurchase $3 billion in shares. The company pays an annual dividend of $2.27 per share for a yield of 2.7%. The dividend payout ratio is 51%.

While it remains doubtful that PepsiCo will buy Mondelez, the other proposal that Nelson Peltz has is for PepsiCo to spin off its beverage business. This actually makes quite a bit of sense. PepsiCo's salty snack business is the market leader, while Pepsi remains number two to Coca-Cola. Peltz has experience in breaking-up food and beverage companies. He was successful in getting Cadbury Schweppes to split up. Cadbury was purchased by Mondelez, and the beverage division is now Dr Pepper Snapple.

PepsiCo, however, is working to turn around its beverage division. The beverage division posted a 1% decline in organic revenue for the second quarter. PepsiCo is cross-marketing its snacks and beverages to appeal to its customers. For instance, pairing Doritos with a Pepsi gets the customer thinking that they need a Pepsi beverage to wash down the Doritos chips. The goal is to increase sales across both salty snacks and beverages. 

A giant competitor

Nestle is the world's largest food and beverage company by revenue. Its products include baby food, bottled water, breakfast cereals, coffee, dairy products, ice cream, pet foods and snacks. Last year, 29 of its brands had over $1 billion in annual sales.

In the first half of this year, total revenue increased 5.3%, while net profit increased 3.6%. Organic revenue grew 4.1%. Sales came in lower than expectations after Nestle cut prices on its products in an effort to lure in shoppers hit hard by the crisis in Europe. The current operating margin did improve by 20 basis points to 15.1%.

What I like about Nestle is that no other company matches it in sheer size and scale. The company uses that to leverage its position in emerging markets. Sales in emerging markets grew 8% in the first half of this year. Latin America and Russia saw growth in the double-digits.

While its size and scale are attributes I like, it's also one of the company's downfalls. Nestle is not a growth stock because of its sheer size. With its market cap over $200 billion, there isn't an activist with enough buying power to push for change. Nestle could easily be broken up into several companies, but that is not likely to happen. The advantage to owning Nestle is that an investor can sleep well at night knowing that its portfolio of consumer staples make Nestle a safe and sound investment.

Going forward, Nestle is looking for price cuts to boost sales in Europe over the next several quarters. The company is also hoping an increase in its marketing budget by 60 basis points will translate into increased sales. Chief financial officer Wan Ling Martello also said that a share buyback was possible and that the company is looking to increase its dividend in absolute terms every year.

Foolish assessment

All three food and beverage companies have great brands and strong businesses in developed and emerging markets. Peltz owns shares in both Mondelez International and PepsiCo. He knows the food and beverage business, as he is the largest shareholder and chairman of Wendy's.

He obviously sees value in both companies and I do as well. I think it's only a matter of time before change occurs at Mondelez International or PespiCo. Change is unlikely at Nestle and that's why Mondelez International and PepsiCo look to have more upside than Nestle.

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool recommends PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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