PepsiCo Needs To Go Further

By Stephen D. Simpson, CFA | February 13, 2012 AAA

An eye on the future is all well and good, but Wall Street will pay relatively little for it if they fear that near-term execution will suffer as a result. Although PepsiCo's (NYSE:PEP) decisions in recent years to prioritize healthier foods may make sense in a world increasingly hostile to sodas and salty snacks, the fact remains that many analysts and investors are much more concerned about the the pace of share erosion today. Although PepsiCo's restructuring efforts announced with fourth quarter earnings are logical, there's a real risk that it's too little, too late.

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Q4 On Target
PepsiCo didn't deliver too many surprises for the fourth quarter. Revenue rose 11% as reported and slightly surpassed the averaged analyst estimate. Real growth was more on the order of around 9%, though, as an extra week and foreign exchange both impacted reported results.

Overall beverage volume growth of 3% was OK, but nothing special relative to what Coca-Cola (NYSE:KO) reported a couple of days before. Global snack volume of 8% wasn't bad, though. Looking at the segments, Frito-Lay was pretty solid, while Quaker Foods and the beverage business were both soft.

Gross margin fell more than two points as reported, while GAAP operating income was up just 1%. Division operating profits were up 7%, though, and adjusted operating income rose 11%. All in all, PepsiCo basically did what was expected on profits. (For related reading, see Analyzing Operating Margins.)

The New Plan - Does It Go Far Enough?
Wall Street has been waiting to see something dramatic from PepsiCo management as it pertains to reigniting growth. After all, PepsiCo has been losing share in sodas (some to Coca-Cola, some to private label companies like Cott (NYSE:COT), juices (to Coca-Cola, Kraft (NYSE:KFT), and several others), and snack foods (mostly to private labels) for a couple of years.

The question is whether this plan solves PepsiCo's problems.

Arguably, the key to success lies in the plan to increase marketing spending by a range of $500 million to $600 million in 2012, with incrementally higher marketing spend (as a percentage of sales) in the years following. Much of this will be focused on North America, with attention paid not just to advertising but also on in-store presentation and distribution routes.

That sounds nice, and it is, but it's a strategy that may fail to deliver the hoped-for results. Coca-Cola can easily match any incremental spending in beverages. Likewise, Kellogg (NYSE:K), ConAgra Foods (NYSE:CAG) and Kraft (post-stock split) can certainly respond with marketing investment of their own if this proves to really drive any share back towards PepsiCo.

To pay for this plan, PepsiCo is also launching a thee-year $1.5 billion "productivity plan" that will include employee firings, facility consolidations and improved/streamlined internal systems.

Unfortunately, this plan may not drive all that much improvement in long-term performance. It doesn't seem to address PepsiCo's relative overseas weakness (in comparison to Coca-Cola or Kraft, at least). It also doesn't address a model that arguably makes less sense as time goes on - companies like Kraft, Sara Lee (NYSE:SLE) and Ralcorp (NYSE:RAH) have recently announced/launched splits or spin-offs and it's unclear at present whether all of PepsiCo's pieces really fit together (particularly Quaker). (For additional reading, see Understanding Stock Splits.)

The Bottom Line
PepsiCo is far from a bad business; it's just not as good as it could be when you compare it to companies like Coca-Cola or Kellogg. Unfortunately, I suspect that this latest strategic investment plan is not going to fire up the shareholder base, nor ease the pressure on management to deliver better results here and now.

PepsiCo is modestly undervalued now, but not so much so that I'm interested in owning it. It's admittedly hard to find consumer goods stocks that are both better and cheaper, and the PepsiCo dividend is pretty attractive, but I'd rather pay too much to own Kellogg or Coca-Cola. (To learn more, check out Valuing Large-Cap Stocks.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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