2 Changes Could Make PepsiCo Relevant Again

By Chad Henage - October 20, 2012 | Tickers: KO, DPS, MNST, PEP | 0 Comments

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Okay PepsiCo (NYSE: PEP), your way isn't working. It's time for you to realize that there is a better structure for your business. Shareholders deserve to see the real value that lies beneath the current operating structure. Each quarter that passes, the challenge to compete effectively becomes more difficult. You've done this before when YUM Brands was spun-off and that was the right move. There are two more moves that need to happen to unlock value for investors and they need to happen now.

Sodas Are No Longer Where It's At:

This must be what a lot of PepsiCo investors are thinking. The company's current earnings paint a clear path to better returns for shareholders, but management needs to get on board. In the beverage industry there are three categories pushing forward growth, and PepsiCo just isn't marketing its brands with enough force. The three growth categories in beverages are: teas, pre-packaged water, and energy drinks. I know years ago investors would have never thought that brands like Aquafina, Lipton, and Gatorade could become more important than Pepsi, but that's what happened. In Coca-Cola's (NYSE: KO) recent earnings, the company reported 3% volume growth in sparkling beverages (sodas) and 10% growth in still beverages (tea, water, energy drinks). When the top player in the industry sees better growth in still beverages, you can bet that PepsiCo, Dr. Pepper Snapple (NYSE: DPS), and even Monster Beverage (NASDAQ: MNST) better pay attention. Though PepsiCo doesn't report its results based on brand segments like Coca-Cola does, let's take a look at the company's earnings and see where there is opportunity for improvement.

PepsiCo Earnings:

In the recent quarter, PepsiCo saw revenue down 5%, but long story short it would have been up 5% if not for structural changes and foreign currency impact. While I can accept 5% organic growth in revenue, what was disappointing was the company's EPS down 3.2%. PepsiCo says the, “Company expects to deliver more than $1 billion in productivity savings in 2012 and $3 billion by 2015.” Considering that PepsiCo is expected to see the slowest growth in earnings among their peers in the next few years, the faster the company can get earnings moving again the better. When investors can get 7% to 8% expected EPS growth from Coca-Cola or Dr. Pepper Snapple, or 15% earnings growth from Monster Beverage, they would be hard pressed to explain accepting 4.7% growth from PepsiCo. So what are the two big ideas to make PepsiCo relevant again?

#1 - Throw Out Quaker Like Day Old Oatmeal:

I've said this before in a prior post, and I'll say it again, Quaker makes no sense for PepsiCo. I know the reason the company owns the brand is Quaker owned Gatorade and PepsiCo wanted Gatorade. That was a smart move, and Gatorade should stay, but the rest of the Quaker brands are a drag on results. In 2010, Quaker revenue was down 1%, and in 2011 revenue was flat. Last quarter, Quaker revenue was down 3% and net income dropped 10%. This quarter revenue was flat, and net income dropped 11%. What more evidence does the company need? Whether management dumps this division as a spin-off or sells it outright, it needs to go.

#2 – Let The Chips Fall Where They May:

The original theory was Frito-Lay and Pepsi beverages would compliment each other. The problem is, it seems that management isn't focusing enough on either business individually. Frito-Lay is performing well, but Pepsi beverages are struggling. In the Americas, Frito-Lay showed a 1% volume increase, Latin America showed a 4% volume increase, and in Asia, the Middle East, and Africa the company saw “double digit volume growth in snacks.” These are the type of results that would get investors excited. In the Americas alone, Frito-Lay represented about 48% of revenues so it's reasonable to assume a Frito-Lay split would entail an equal split of PepsiCo as it currently exists. The bottom line is, Frito-Lay continually outperforms Pepsi beverages, and the growth of this division isn't being appreciated by the market.

How Does Pepsi Beverages Become More Competitive?

Even if we assume management takes these steps, there is still one problem, Pepsi beverages has to find a way to be more competitive. Looking at the current quarter results, beverages volume was down 3% in the Americas, up 1% in Europe, and up in the “high single digits” in the rest of the world. These aren't bad results, but they won't get many investors excited about the company either. In the growth areas of tea, water, and energy drinks, PepsiCo has a strong brand in two of the three categories.

Aquafina is a strong offering going up against the likes of Dasani (Coca-Cola), and Deer Park (Nestle) in the pre-packaged water segment. Since Coca-Cola saw a 10% increase in pre-packaged water sales, it's reasonable to expect Pepsi could match these results. In the tea segment, Pepsi needs to advertise more. The company's primary competitor is Snapple from Dr. Pepper Snapple and to a lesser extent Peace Tea, which is an offering by Monster Beverage. Pepsi's two primary brands are Brisk and Lipton, but I can't remember the last time I saw an advertisement for either.

The fastest growing segment in beverages is energy drinks. Monster and Red Bull are the two co-kings of the hill in this segment of the market. With Monster showing volume growth of nearly 30% in their last quarter, it's clear that this is a market that Pepsi needs to be a major player in. Pepsi and Dr. Pepper Snapple both are struggling in this segment of the market. Pepsi has the Amp brand, and Dr. Pepper Snapple offers Venom, but compared to Monster, Red Bull, or even Full Throttle (Coca-Cola), these brands really don't get much consideration. Since Coca-Cola is the bottler of choice for Monster, a purchase seems unlikely. If I were PepsiCo management, I would heavily consider either looking at a big acquisition in the space along the lines of Red Bull (privately held) or even consider buying the privately held Rockstar brand, which the company already distributes in the U.S. With Red Bull holding about 40% of the energy drink market, Rockstar at about 19%, and Pepsi's own AMP brand at just 4.4%, you can see what a huge difference either deal would make. With volume growth solidly in the double-digits, a larger presence in the energy drink market would give PepsiCo beverages a new growth driver for the future.

Conclusion:

As you can see, PepsiCo has some opportunities to improve shareholders fortunes. The longer management waits to make these moves, the less patient shareholders are likely to be. A smaller more focused Pepsi beverages would be able to concentrate on expanding its drink offerings, and an energy drink purchase would make the remaining company more attractive. An independent Frito-Lay would give shareholders a chance to own this growing company on its own, and would unlock value for existing investors. Quaker Oats dismissal would cut this dying division off before it hurts results even further. Pepsi's slogan is “Live For Now,” this is the right attitude, and these changes would make PepsiCo relevant once again.

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