As seems to be the case with Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP) is not presently delivering the sort of results that its premium valuation would seem to demand. Certainly some of this can be tied to investor confidence - Coca-Cola and PepsiCo may wobble from time to time, but they eventually get their affairs in order and get back to the business of wringing above-average profits from strong global brands. That said, while I do believe PepsiCo has some good things going for it, I see no reason to pay up for the stock today.

Investopedia Broker Guide: Enhance your trading with the tools from today's top online brokers.

A Quarterly Beat, but not a Great Performance
For PepsiCo, the third quarter was another one where there was some 'splainin' to do. The company did beat the bottom line estimate, but the quality of the win was a little weak (powered by below-the-line numbers) and the core North American beverage business is not firing on all cylinders.

Revenue was down 5% on a reported basis, but up 5% on an organic basis (edging out Coca-Cola's organic growth for the same quarter). Growth was heavily weighted toward pricing/mix, as volume increased 1%. The PepsiCo Americas Beverage unit saw flat organic performance, while Foods rose 6%, Europe rose 7%, and Asia, Middle East and Africa rose 10% (with emerging markets up about 11% overall).

On the profits side, gross margin did improve more than a half-point from last year. Operating income fell 8%, however, and both the Americas beverage and food segments were a little soft in terms of profit performance.

SEE: Everything Investors Need To Know About Earnings

Beverages - Mix, Competition and Promotion
PepsiCo's 4% decline in North American beverage volume jumped out at me this quarter, with carbonated beverage volume down 2% and still beverage volume down 7%. It certainly backs up the Nielsen data that indicated Coca-Cola was picking up share in water and sports beverages, and it sounds as though PepsiCo's Tropicana business was down in the double-digits.

This business flummoxes me a bit right now. On the one hand, PepsiCo is fine with losing share in the lower-margin case water business, and I don't dispute that decision at all (higher water sales didn't help Coke's margins). Likewise, getting out of less-profitable juice businesses makes sense. On the other hand, the company has been committing a lot of resources to this unit (North American beverages in general, that is), and it doesn't seem to be paying a lot of dividends. Even if companies such as Cott (NYSE:COT) are benefiting from a shift to cheaper, store-brand soda, it's not a good performance.

Good Overseas Performance
In contrast to North American results, PepsiCo is doing well overseas - seemingly better than even Coca-Cola in China. For reasons that don't always make a lot of sense, PepsiCo and Coca-Cola are frequently compared to other consumer companies such as Procter & Gamble (NYSE:PG) and Colgate Palmolive (NYSE:CL) in emerging market sales, and PepsiCo seems to be holding its own at present, with generally solid volumes across the board.

SEE: What Is An Emerging Market Economy?

Product Development Should Pay Off
PepsiCo has arguably been too lax in product development in recent years, and is paying for it with share weakness relative to Coca-Cola in beverages and companies such as Kraft (Nasdaq:KRFT) and Kellogg (NYSE:K) in snacks. Time will tell if the company's efforts here can pay dividends; PepsiCo has been working with ingredient/flavor developers such as Senomyx (Nasdaq:SNMX) in the hopes of developing better sweeteners, and the company's venture with Yum! Brands (NYSE:YUM) for the Doritos-flavored taco shell shows some of the benefits of thinking outside the box with flavor and brand extensions.

SEE: Lead The Charge With Product Development

The Bottom Line
Given PepsiCo's relatively long history as a performance laggard, I'm surprised by the extent to which analysts and investors give the company the benefit of the doubt with their models. Historically, PepsiCo has only delivered about 60% of the free cash flow margin of Coca-Cola and only about one-third more than packaged food players like Kraft and Kellogg.

Let's say that PepsiCo does better and lifts that free cash flow margin into the mid-teens over the next decade, while continuing to grow revenue at a low-to-mid single-digit clip. That points to roughly 10% compound annual free cash flow growth, but a fair value in the low $70s. So even if the company does meaningfully better than it has, there's not a lot of apparent upside to me in the stock. That said, I know the Street loves and believes in this name, so any real pullback would probably be an opportunity for investors who wish to bet that the love affair will continue.

At the time of writing, Stephen D. Simpson owned shares of Senomyx since 2007.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  3. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  4. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  5. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  6. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  9. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  10. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!