The Secret To PepsiCo’s Success Isn’t Soda

By Jonathan Berr | October 18, 2013 AAA

PepsiCo. (NYSE:PEP) may be losing the Cola Wars to rival Coca-Cola (NYSE:KO), but it’s winning the hearts and minds of investors.

The beverage and snacks company reported quarterly earnings on Oct. 16 that were better than Wall Street analysts or activist investor Nelson Peltz, who has called for the company to split itself in two, expected. Shares of PepsiCo. ,which have gained more than 20% this year compared with Coca-Cola’s 4.8%, traded up on the news rising 2% to $82.27 at the close of the market. Dr. Pepper Snapple​ (NYSE:DPS), another rival, has edged up about 2% this year.

Net income in the last quarter at the Purchase, N.Y.-based company inched up 0.6% to $1.91 billion, or $1.23 per share, as the strength in its snack business outweighed the weakness in its core beverage operations. Adjusted for one-time items, profit was $1.24, beating the $1.17 average estimate of analysts surveyed by Bloomberg. Revenue jumped 1.5% to $16.9 billion, slightly under the $17 billion expected by Wall Street.

The North American snack divisions' revenue, which includes Frito Lay, rose 7% on a currency neutral basis. Organic revenue in the Latin American snacks business rose by double-digits. PepsiCo. saw gains in volume, value and unit market share in its U.S. salty snacks operation.

During the quarter, PepsiCo. had six of the top 25 new food and beverage introductions and seven of its products are on the pace to achieve $100 million in annual sales including Mountain Dew KickStart, Tostitos Cantina and Starbucks Iced Coffee and Gatorade Frost Glacier Cherry.

The performance may help CEO Indra Nooyi counter efforts by Peltz and other investors to force PepsiCo. to sever its faster growing snacks business from its slower growing beverage operations. Earlier this year, Peltz called on PepsiCo. to acquire Mondalez International (Nasdaq:MDLZ), the parent of Oreo cookies and Trident gum, and merge it with her company’s snack business. Nooyi has rejected the idea, which seems like a good move. During its latest quarter, Mondalez reported revenue growth that was below its internal projections because of lower coffee prices and struggles in its gum business.

Nooyi reiterated her position in the earnings conference call. that the company’s diverse businesses are an asset.

“In challenging times such as these it's especially important to stay focused on execution and that’s really what we’re doing, focusing on the fundamentals to drive good, sustainable performance,” she said. “…overall our business is on track and we are pleased with the progress we have made strengthening our competitive position across our key developed, developing and emerging markets.”

The problem that faces PepsiCo. and rivals including Coca-Cola, Dr. Pepper Snapple Group is the soda business. Per-capita soda consumption has been on the decline for years thanks, in part, to efforts by public health groups such as the Center for Science in the Public Interest to link its consumption to obesity. In fact, soft drink consumption has hit a 26-year low. The industry has been promoting zero and low-calorie alternatives to limited effect.

PepsiCo. trades at a price-to-earnings multiple of 19.39, slightly cheaper than Coca-Cola’s 19.68, but below Dr. Pepper Snapple’s 15.34. The average 52-week price target on the maker of Pepsi and Mountain Dew is $90.67, about 10% higher than where it currently trades. Coca-Cola has a 16% potential upside and Dr. Pepper Snapple’s 8%.

The Bottom Line

Based on recent earnings, it seems like Nooyi’s strategy of banking on food and beverages simultaneously is paying off. Carbonated beverages are getting harder and harder to market and growth there will be a challenged for years to come. PepsiCo., though, is well positioned in the faster-growing sports and energy drink categories thanks to products such as Gatorade and Amp. The time to buy this stock is now.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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