Pepsi’s New Direction: Great For Shareholders

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

PepsiCo (NYSE: PEP) has a strong presence in the world beverage market, but unbeknownst to many is the fact that PepsiCo produces roughly half of its revenue each year through its foods division that owns popular brands such as Doritos, Quaker, Frito-Lay and Tostitos. While PepsiCo competes directly with the beverage behemoth Coca-Cola (NYSE: KO) and the smaller beverage giant of the Dr. Pepper Snapple Group, it also competes with Kraft Foods (NASDAQ: KRFT) and Nestlé in the foods market. The company’s versatility and presence in multiple markets provides it with an economic moat that reduces the risk of investing in the company and secures long term returns for its shareholders.

PepsiCo maintains solid footing in the carbonated beverage industry and has performed well against its main rival, Coca-Cola with its seasonal Mountain Dew offerings that vary each season and its Pepsi Cola product. As consumers have begun to become more health conscious and move away from heavily sugared and carbonated soft drinks, PepsiCo has shifted its focus into its Lipton Tea and Tropicana brands, which provide an assortment of teas and juices. The Dr. Pepper Snapple Group competes with PepsiCo in the tea segment with Coca-Cola pushing back against the Tropicana line with its Minute Maid brand.

A recent probe by the Food and Drug Administration into both Minute Maid and Tropicana may end up hurting both PepsiCo and Coca-Cola, however, after traces of fungicide were found in each brand’s orange juice products. While the initial reports state that the fungicide is nontoxic, the reports themselves will continue to push health conscious consumers away due to the growing trend toward natural foods and beverages with minimal additives. The Dr. Pepper Snapple Group has been taking advantage of this shift by advertising its All Natural line of products.

Where PepsiCo has strength is in its food brands, which compete with Nestlé and Kraft Foods in grocery stores across the globe. Its snack brands also have exposure in convenience stores and gas stations as impulse buys for travelers to snack on over a long drive. PepsiCo plans to make more moves toward providing healthier food as well and already has a footing in the market with its Quaker brand of foods and snacks.

PepsiCo has excelled against its competitors in both the food and beverage markets, showing revenue growth of 13% over the last year which was slightly higher than Kraft Foods’ 11% and well above the 5.2% and 4.9% growth shown by Coca-Cola and the Dr. Pepper Snapple Group, respectively. Its acquisition of the Russian dairy and juice company, Wimm-Bill-Dann has allowed PepsiCo to make a play in Russia and Asia in both the food and beverage markets, widening its economic moat.

The acquisition added $12.6 billion to PepsiCo’s debt load, but its increase in assets has justified its liability. PepsiCo now has $75.3 billion in assets and carries $58.1 billion in liabilities. Its profits have risen over the last three years from $5.1 billion in 2008 to $5.9 billion in 2009 and $6.3 billion in 2010. In the first three quarters of 2011, PepsiCo reported net revenue of $4.9 billion, on track to continue its steady incline.

PepsiCo provides a quarterly dividend of $0.51 per share, for a total of $2.06 per share over the last four quarters. Its quarterly payout provides more opportunity to compound returns for income investors and it is currently paying out at a ratio of 0.52 with a projected yearly yield of 3.2%. I believe that despite its declining carbonated beverage sales, PepsiCo has established enough of a safety net here to protect its dividend and continue to provide returns to its shareholders.

Kraft Foods is the largest threat to PepsiCo in the food market, but I believe that PepsiCo has a broad range of products that allow it to compete and its expansion into the Russian and Asian markets will protect it against any pressure that it receives from Kraft. Nestlé has an extremely strong presence in the Chinese coffee market, which it plans to solidify even further in 2012, but I don’t believe that Nestlé poses a great threat to PepsiCo’s expansion into the Asian market due to PepsiCo’s ability to offer a variety of food products in addition to its beverages.

Over the last three years, PepsiCo stock has grown in value from $47 per share to $63 and I believe that its wide economic moat will protect it against the incursions it will undoubtedly face from the Dr. Pepper Snapple Group in the natural tea and juice market and the opposition it will meet against Nestlé when it expands into China. PepsiCo shows itself to me as a lower risk buy with long term growth potential and consistent dividend gains that can be reinvested for a stronger position in the company.


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