Diversification Is Key for PepsiCo in 2014 And Beyond

Thursday, January 9, 2014

Diversification Is Key for PepsiCo in 2014 And Beyond

Pepsico, Inc. (NYSE:PEP), which is generally, known for its soft drinks and snacks businesses has been in the news for tying up with Buffalo Wild Wings (NASDAQ:BWLD) which will allow it to sell its drinks at the 975 outlets that the latter has. Considering the fact that the soft drinks market is in decline due to the changing consumer demands this deal should help the company offset the decline in revenue from falling sales. 
Image credit: lightwise / 123RF Stock Photo

Not only this, company's highly diversified business means that even as soft drinks sales decline sales of snacks are on the rise. When these factors are considered along with PEP's attempts at expansion abroad, its performance in recent quarters and the perfect dividend history that it has, the company appears to be an excellent choice.

What the deal with Buffalo Wild Wings Means
PepsiCo recently replaced rival Coca-Cola (NYSE:KO) as the supplier of beverages to the rapidly expanding Buffalo Wild Wings. This relationship should prove beneficial to both since Buffalo Wild Wings will not only mention Pepsi's beverages but also provide a new menu which includes the company's Doritos. This does not mean that rival Coca-Cola, which currently has a 70% market share in the US, will lose out to PepsiCo, but it does mean that PEP's products will now be served in 975 restaurants across 49 states (and Canada), helping PEP improve upon its current market share.
Further, the agreement will help PepsiCo cushion the revenue decline caused by a dip in soft drink sales. PepsiCo CEO Indra Nooyi has admitted that they have been falling 3% annually.
Great diversification, international prospects
The major difference between Coca-Cola and PepsiCo lies in the share of income that they derive from soft drinks. While Coca-Cola earns 75% of its revenue from carbonated drinks sales, the figure for Pepsi is just 25%. Rather, the latter's leading source of earnings growth has been its snack brand Frito-Lay. Snack sales have been growing in recent years both in the US and abroad.
If we look at the international market, sale volume in Asian countries like China grew steadily helping Pepsi's Q3 figures. The company is now focusing upon China, which is expected, to become the largest beverage market soon and largest snacks market in about a decade according to Forbes. To cash in on this demand the company plans to invest in Myanmar. In the meantime, it will try to build up a strong customer base in both snacks and drinks segments through distributors and also try to create a reliable supply chain for ingredients like potatoes by working with local farmers. Hence, while Coca-Cola has apparently stolen a march by opening a bottling plant in Myanmar, Pepsi's broad based policy should prepare for the company a solid foundation from which it can rapidly elevate its fair share.
Those vital statistics
Pepsi's CAGR for revenue stands at 8.65% for the last five years, leading to a leap from $43.2 billion in 2008 to $65.5 billion in 2012. Growth figures for 2012 show that though soft drinks continue to provide the greatest percentage of revenue, the sector only provide $2.97 billion in profit. Compare this to the $3.65 billion in operating profit (about 35% of total operating profit) that the company earned in the same period from Frito-Lay, and one realizes why Pepsi's diversification is such a crucial difference between it and Coca-Cola.
Further, whereas Coca-Cola's YTD return stands at 3.82%, Pepsi's figure is a delightful 15.08%. Indeed, Pepsi's YTD return is considerably better than the sector's 9.77%.
Finally, Pepsi has been providing rising dividends for 41 years and has been able to reach its dividend at a CAGR of 9.45% in the last decade. According to analysts the EPS growth for the next five years should be in the range of 7.95%. With a payout ratio of 50%, the company should be able to continue raising its dividend without much difficulty. If that weren't enough, the company announced a share buyback of $10 billion, which at current prices would imply a buyback of about 8% of the company's current float.
Investor's decision
Despite the lead that Coca-Cola enjoys in the beverage industry, PepsiCo's amusing diversification and recent deal with Buffalo Wild Wings puts it in a far better position vis a vis Coca-Cola. Additionally, the company has a clear policy regarding international markets and a rise driven by snacks. These, coupled with excellent statistics indicate that PEP will continue to grow in the coming years. As such, investors who already have the company's stock would be advised to "hold" while those looking for a company with strong dividend growth in this sector would be advised to invest in the company's stock.
Author: Justin Martin

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