PepsiCo, Inc.
(NYSE: PEP)
Price Target: $74.00
Recommendation: BUY
Fund:
Ohio State University SIM Fund
Fund Manager: Chris Henneforth, CFA
Royce West, CFA
Analyst:
Report Date: June 1, 2010
Lourdes R. Dudaney
Fisher College of Business
The Ohio State University
Columbus, Ohio
Dudaney.1@osu.edu, 614.354.6578
Table 1 Highlights of Stock Performance
Investment Thesis
PepsiCo is one of the largest consumer products companies
manufacturing and selling a wide range of snacks, nonalcoholic beverages and food globally. While growth in
carbonated soft drinks (CSD) is expected to be stagnant,
PepsiCo is focusing on its growing non-CSD business which it
plans to expand through product innovation. The acquisition of
its two largest bottlers in North America will help PepsiCo
bring these new products to market faster and more efficiently.
The company is growing in the international market as well.
To accelerate its growth, PepsiCo is investing in infrastructures
in key emerging countries. It announced recently that it is
investing $2.5 billion in China.
PepsiCo, which dominates the snack food industry, is one of
the leading companies to focus on health and nutrition in its
product development through innovations in healthier oils,
sodium reduction, and the addition of healthy
ingredients.
Sector
Industry
Consumer Staples
Food and NonAlcoholic Beverage
Market Data
Current Price
52-week high (05/12/2010)
52-week low (05/29/2009)
Average Daily Volume
Market Capitalization (MM)
Shares Outstanding (MM)
Dividend Yield (Annual)
62.89
67.61
50.85
7,806,765
$101,424
1,612.72
2.864
Financial Summary
EV/EBITDA
Book Value/Share
Total Debt (MM)
Return on Equity
Long-Term Debt (MM)
Risks
 There is the risk of missteps in integrating the
two bottlers, the Pepsi Bottling Group, Inc.
(PBG) and PepsiAmericas, Inc. (PAS) preventing
the company to fully realize the benefits and cost
savings expected from the acquisitions.
 Currency risk increases as PepsiCo derives a
greater proportion of its revenue from its
international operations.
 PepsiCo operates in 200 countries exposing it to
political risk.
 Increasing commodity prices will affect
PepsiCo‟s performance since it is dependent on
agricultural commodity products. Prices are
dependent on global demand and supply and are
sensitive to extreme weather conditions.
Figure 1 12-month Price Performance Graph
12.61
13.34
21,858
41.24%
19,884
PepsiCo Company Report
TABLE OF CONTENTS
COMPANY OVERVIEW
PEPSICO BUSINESS UNITS
INGREDIENTS AND OTHER SUPPLIES
CUSTOMERS
DISTRIBUTION NETWORK
COMPETITIVE ADVANTAGE
MACROECONOMIC ANALYSIS
COMMODITY PRICES
DEMOGRAPHIC TRENDS
3
3
5
5
5
6
6
9
10
CONSUMER STAPLES SECTOR
10
FOOD AND NON-ALCOHOLIC BEVERAGE INDUSTRY
13
SNACK FOOD INDUSTRY
SOFT DRINK INDUSTRY
COMPANY ANALYSIS
FUNDAMENTAL DRIVERS
FINANCIAL ANALYSIS
LIQUIDITY
LEVERAGE
COMPANY VALUATION
DISCOUNTED CASH FLOW (DCF) ANALYSIS
13
14
15
15
16
19
21
22
24
RISKS
26
CONCLUSION
26
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PepsiCo Company Report
List of Figures
Figure 1 12-month Price Performance Graph ......................................................................................................... 1
Figure 2 Net Revenue and Operating Income Breakdown ....................................................................................... 4
Figure 3 Macroeconomic Factors Relevant to PepsiCo ........................................................................................... 7
Figure 4 Commodity Prices .................................................................................................................................... 9
Figure 5 Snack Food Industry Product Segmentation ............................................................................................ 14
Figure 6 Product and Market Segmentation .......................................................................................................... 15
List of Tables
Table 1 Highlights of Stock Performance ................................................................................................................ 1
Table 2 Consumer Price Index: Food...................................................................................................................... 8
Table 3 US Population Statistics by Age ............................................................................................................... 10
Table 4 Consumer Staples Sector Industries and Companies ................................................................................. 11
Table 5 S&P 500 Sector Performance ................................................................................................................... 12
Table 6 Dividend Yield by Sector .......................................................................................................................... 12
Table 7 Consumer Staples Valuation..................................................................................................................... 13
Table 8 PepsiCo Proforma Income Statement ....................................................................................................... 17
Table 9 PepsiCo Profitability Ratios ..................................................................................................................... 18
Table 10 PepsiCo Earnings Per Share .................................................................................................................. 18
Table 11 Coca-Cola Profitability Ratios ............................................................................................................... 18
Table 12 Coca-Cola Earnings Per Share .............................................................................................................. 19
Table 14 Comparative Profitability Ratios ............................................................................................................ 19
Table 13 Comparative EPS 2009 .......................................................................................................................... 19
Table 15 PepsiCo Liquidity Ratios ........................................................................................................................ 20
Table 16 Comparative Liquidity Ratios FY 2009 ................................................................................................... 20
Table 17 PepsiCo Leverage Ratios ....................................................................................................................... 21
Table 18 Comparative Leverage Ratios FY 2009................................................................................................... 21
Table 19 Target Price Based on Valuation Multiples............................................................................................. 22
Table 21 PepsiCo Valuation Relative to the Soft Drink Industry ............................................................................ 22
Table 20 PepsiCo Valuation Relative to S&P 500 ................................................................................................. 22
Table 22 Comparative Company Valuations ......................................................................................................... 23
Table 23 PepsiCo Discounted Cash Flow Model ................................................................................................... 25
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PepsiCo Company Report
Company Overview
PepsiCo Inc. is a leading global food, snack and beverage company. The company manufactures
and sells a variety of oat, rice and grain-based snacks, carbonated and non-carbonated beverages
and food products in over 200 countries. Its largest operations are in North America (United
States, Canada and Mexico) and the United Kingdom.1
PepsiCo Business Units
PepsiCo is organized into three business units as follows:



PepsiCo Americas Foods (PAF) which includes Frito-Lay North America (FLNA), Quaker
Foods North America (QFNA) and all PepsiCo Latin American food and snack businesses
(LAF).
PepsiCo Americas Beverages (PAB), which includes PepsiCo Beverages North America and
all Latin America PepsiCo beverage businesses
PepsiCo International (PI), which includes all PepsiCo businesses in Europe and all PepsiCo
businesses in Asia, Middle East and Africa (AMEA).
The six divisions under these business units are described in more detail below.
Frito-Lay North America (FLNA)
FLNA manufactures and sells branded snack foods including Lays and Ruffles potato chips,
Doritos and Tostitos tortilla chips, Cheetos cheese flavored snacks, Quaker Chewy granola bars
and SunChips multigrain snacks. FLNA‟s net revenue was $13.2 billion in 2009, the largest in
the company, representing 31% of the company‟s total revenue for that year.
Quaker Foods North America (QFNA)
QFNA manufactures and sells cereals, rice, pasta and other branded products which includes
Quaker oatmeal, Aunt Jemima mixes and syrups, Cap „n Crunch cereal, Rice-A-Roni, Pasta Roni
and Near East side dishes. QFNA‟s net revenue was $1.9 billion in 2009, the smallest in the
company, representing 4% of the company‟s total revenue for that year.
Latin America Foods (LAF)
LAF manufactures and sells snack food brands including Gamesa, Doritos, Cheetos, Ruffles,
Lays, Sabritas and Quaker brand cereals and snacks. LAF‟s net revenue was $5.7 billion in 2009
representing 13% of the company‟s revenue for that year.
PepsiCo Americas Beverages (PAB)
PAB manufactures and sells beverage concentrates, fountain syrups and finished goods under a
variety of well-known brands including Pepsi, Mountain Dew, Gatorade, 7UP, Tropicana Pure
1
Source: PepsiCo Inc. 10-K Fiscal 2009
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PepsiCo Company Report
Premium, Sierra Mist, Propel, Manzanita Sol, Tropicana juice drinks, SoBe Lifewater, Dole and
Amp Energy. PAB also manufactures and sells ready-to-drink tea, coffee and water products
through joint ventures with Unilever under the Lipton brand and Starbucks. It licenses the
Aquafina water brand to its bottlers and markets the brand. PAB‟s net revenue was $10.1 billion
in 2009 representing 23% of the company‟s revenue for that year.
Europe
Europe manufactures and sells both PepsiCo brand snack foods including Lay‟s, Walkers,
Doritos, Cheetos and Ruffles, and its beverage brands including Pepsi, 7UP and Tropicana.
Similar to the PAB arrangements, Europe licenses the Aquafina water brand to its authorized
bottlers and manufactures and sells Lipton brand ready-to-drink tea. Europe‟s net revenue was $
6.7 billion in 2009 representing 16% of the company‟s total net revenue.
Asia, Middle East & Africa (AMEA)
AMEA manufactures and sells various PepsiCo snack food brands including its international
brands such as Lays, Doritos, Cheetos and Ruffles, regional brands such as Kurkure, Chipsy,
Smith‟s, Red Rock Deli, many of the Quaker-brand cereals and snacks as well as beverage
concentrates, fountain syrups and finished goods, under its various beverage brands such as
Pepsi, Mirinda, 7UP and Mountain Dew. Aquafina water brand is licensed for manufacturing to
authorized bottlers and manufactures and sells Lipton ready-to-drink tea. AMEA‟s net revenue
was $ 5.6 billion in 2009 representing 13% of the company‟s total net revenue.
Net Revenue by Segment
Net Revenue by Business Unit
AMEA
13%
PepsiCo
International
29%
FLNA
31%
Europe
16%
PAB
23%
LAF
13%
QFNA
4%
AMEA
8%
Operating Income by Segment
Europe
11%
PepsiCo
Americas
Foods
(PAF)
48%
PepsicCo
Americas
Beverages
(PAB)
23%
PepsiCo
International
19%
Operating Income by Business Unit
FLNA
38%
PAB
25%
LAF
11%
QFNA
7%
PepsicCo
Americas
Beverages
(PAB)
25%
PepsiCo
Americas
Foods (PAF)
56%
Figure 2 Net Revenue and Operating Income Breakdown
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PepsiCo Company Report
Ingredients and Other Supplies
The principal ingredients for its food and beverage businesses are juices like apple and pineapple
juices, aspartame, corn, corn sweeteners, flavorings, flour, grapefruits and other juices, oats,
oranges, potatoes, rice seasonings, sucralose, sugar, vegetable and essential oils and wheat. The
key packaging materials include plastic resins including polyethylene terephthalate (PET) and
polypropylene resins used for plastic beverage bottles and film packaging used for snack foods,
aluminum used for cans, glass bottles and cardboard. Fuel and natural gas are important
commodities since these are used in the plants and in the trucks delivering products. These
ingredients, raw materials and commodities are purchased mainly in the open market. To reduce
the impact of volatility in raw materials and energy costs, PepsiCo uses hedging strategies, fixedprice purchase orders and pricing agreements.
Customers
PepsiCo customers include authorized bottlers and independent distributors such as food service
distributors and retailers. Bottlers have exclusive contracts to manufacture and sell certain
beverage products within a specific geographic area.
PepsiCo, Inc. completed its $ 7.8 billion acquisition of its two largest bottlers in North America,
Pepsi Bottling Group Inc. (PBG) and PepsiAmericas, Inc. (PAS) on February 26, 2010 giving
PepsiCo 80% of the volume in North America. The bottler acquisitions will provide PepsiCo the
flexibility to decide how its beverages are distributed as consumer tastes shifts from carbonated
soft drinks into noncarbonated beverages such as water, juices and teas. PepsiCo expects the
transactions to create pre-tax cost savings of about $125 to $ 150 million starting 2010 and
approximately $400 million annually starting 2012. The initial synergies are due primarily due to
greater cost efficiencies but expect synergies due to a combination of cost savings and new
revenue-generating opportunities in later years.
Retail consolidation and the economic environment have increased the power of major retailers
such as Wal-Mart which represented 13% of its total net revenue in fiscal 2009.
Distribution Network
PepsiCo products are brought to market through the following channels:



Direct-Store-Delivery (DSD) – Bottlers and distributors operate DSD systems that directly
deliver snacks and beverages to the retail stores. DSD enables PepsiCo to display its
merchandize to maximize its visibility and appeal. This distribution method is ideal for
products that are restocked often and promoted in-store
Customer Warehouse – PepsiCo delivers products to customer warehouses and retail stores.
These is a less expensive system that work best for products that are not fragile, have longer
shelf life, lower turnover and less likely to be an impulse purchase.
Foodservice and Vending – PepsiCo sales force distribute snacks, food and beverages to
third-party foodservice and vending distributors and operators. This is the distribution
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PepsiCo Company Report
network that supplies products to restaurants, businesses, schools, stadiums and similar
locations.
Competitive Advantage
PepsiCo owns a broad portfolio of globally recognizable brand name products with 19 product
lines generating at least $1 billion in sales. It has global reach in that it operates in 200 countries.
It is best known for its lines of carbonated soft drinks (CSD) which has been part of the
American culture for a long time. In addition, its syrup recipes used to manufacture drinks is a
secret and protected by trademark. Manufacturers pay for licenses to PepsiCo to manufacture and
sell beverages over a specific geographical area. The company has a well established distribution
channel. Operating in the soft drink industry requires a high level of capital investment such that
producers like PepsiCo which is already established in the market can benefit from economies of
scale.
In addition to its beverage portfolio, PepsiCo has a strong portfolio of snack and food products.
The company benefits from the coincidence of consumption between snacks and beverages. Its
FLNA division dominates the snack industry with 51% market share in the snack industry.
Macroeconomic Analysis
The US economy, in terms of real GDP, is expected to grow by 3.0 % in 2010 compared to a
contraction of 2.9% in 2009. However, unemployment is expected to remain high at above 9%
through the end of this year and higher than 8% by the end of 2011. This will keep consumers
cautious with consumer spending expected to increase by 4.5% from the 2009 lows.
Fears that the European debt crisis will slow down the global recovery spread in May. The
governments of Greece, Portugal, Spain, Italy and Ireland have to cut government spending to
rein in their deficits which meant stifling consumer spending in the region. As a result, the euro
declined against the US dollar to a four year low of $1.2178 on May 26. For US multinationals
with significant operations in the EU countries, this means a decrease in revenue when translated
in dollar terms. Europe represents 16% of PepsiCo‟s net revenue in 2009 with the United
Kingdom as its largest market.
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PepsiCo Company Report
Figure 3 Macroeconomic Factors Relevant to PepsiCo
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PepsiCo Company Report
Although real disposable income is expected to rise by 1.4% together with other income
categories in 2010, continued high unemployment, the effect of sovereign debt crisis in Europe
to the global recovery and other economic issues will continue to weigh in the American
consumers‟ minds suggesting continued restraint in spending. Consumers will continue to focus
on value when making purchasing decisions putting pressure on manufacturer and retailer
margins and may mean trading down or staying with store brands.
Consumer spending for food is estimated to increase by 2.8% but this will be due to increased
prices. In 2010, the Consumer Price Index (CPI) for all food is projected to increase 2.5 to 3.5
percent, both food-at-home (grocery store) and food-away-from-home (restaurant) prices are
expected to increase within the same percentage range. The all-food CPI increased 1.8 percent
between 2008 and 2009. Food-at-home prices increased by 0.5 percent, the lowest annual
increase since 1967 while food-away-from-home prices rose 3.5 percent in 2009. Non-alcoholic
beverage prices are forecasted to rise by 2.5% to 3.5% in 2010. 2
Table 2 Consumer Price Index: Food
2
Source: Bureau of Labor Statistics. Forecasts by Economic Research Service
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PepsiCo Company Report
Commodity Prices
Agricultural commodity prices are expected to flatten. Agricultural commodity prices declined
starting in the middle of 2008 reflecting the decreasing speculation that commodity prices will
keep on rising. Foreign demand was also helped by strengthening of overseas currencies relative
to the US dollar providing foreign buyers more purchasing power. However, this trend has
reversed with the dollar strengthening against the euro and the British pounds. Due to this rising
strength of the US dollar crude oil prices have been declining as well. The EU debt crises might
keep the dollars strong in the next few months.
Figure 4 Commodity Prices
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PepsiCo Company Report
Demographic Trends
Baby boomers refer to Americans born in the post-World War II era, between 1946 and 1964,
with the the oldest of the boomers will turn 65 years of age by 2011. According to U.S. Census
Bureau projections, by 2030 there will be 72 million Americans over age 65 representing more
than 19% of the US population3. With the aging US population, rising life expectancy and rising
healthcare costs, Americans are paying more attention to nutrition. Companies like PepsiCo are
targeting the growing baby boomer population. PepsiCo is expanding its “good for you” product
portfolio focusing on wellness and nutrition with plans to cut sodium, saturated fat and sugar in
the next five years.
Table 3 US Population Statistics by Age
Year 2010
Age
0-14
15-64
65-99
Total
Year 2030
Population
Percent of
Population
62,380,610
207,623,541
40,228,712
310,232,863
20%
67%
13%
100%
Age
0-14
15-64
65-99
Total
Population
Percent of
Population
72,959,056
228,452,703
72,091,915
373,503,674
19.5%
61.2%
19.3%
100%
The US Census Bureau‟s international database shows that world population will increase 20%
by 2030. Only 2.5% of this growth will come from more developed countries with less
developed countries growing 40 times faster than developed ones. Companies which are
positioned to compete in the less developed regions could see substantial growth.
Consumer Staples Sector
The consumer staples sector is a defensive sector consisting of established companies with well
known branded products. It is divided into five industries: the food and staples retailing,
beverage, food products, tobacco, household products and personal products industries. The
industries are further divided into twelve sub-industries. The sector represents 11.31% of the
S&P 500 index. Household products and the soft drink sub-industries are the largest in the sector
with 2.54% and 2.43% weight in the S&P 500, respectively, while the smallest is the brewers
with 0.066% weight in the S&P 500. Wal-Mart has both the largest market capitalization and
annual revenue in the sector with $189 billion market capitalization and annual revenues of $408
billion. Table 4 below shows the industries and companies within the sector and their market
capitalization and latest annual revenue data.
3
Source: U.S. Census Bureau, International Data Base.
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PepsiCo Company Report
Table 4 Consumer Staples Sector Industries and Companies
Industry Group
Food & Staples Retailing
Industry
Sub-Industry
Food & Staples Retailing Drug Retail
Food Distributors
Food Retail
Hypermarkets & Super Centers
Food, Beverage & Tobacco
Beverages
Brewers
Distillers & Vintners
Soft Drinks
Food Products
Agricultural Products
Packaged Foods & Meats
Household & Personal
Products
Tobacco
Tobacco
Household Products
Household Products
Personal Products
Personal Products
Companies
CVS Caremark Corp
Walgreen Co
Sysco Corp
Kroger Co/The
Safeway Inc
SUPERVALU Inc
Whole Foods Market Inc
Costco Wholesale Corp
Wal-Mart Stores Inc
Molson Coors Brewing Co
Brown-Forman Corp
Constellation Brands Inc
Coca-Cola Co/The
Coca-Cola Enterprises Inc
Dr Pepper Snapple Group Inc
PepsiCo Inc/NC
Archer-Daniels-Midland Co
Campbell Soup Co
ConAgra Foods Inc
Dean Foods Co
General Mills Inc
Hershey Co/The
HJ Heinz Co
Hormel Foods Corp
JM Smucker Co/The
Kellogg Co
Kraft Foods Inc
McCormick & Co Inc/MD
Mead Johnson Nutrition Co
Sara Lee Corp
Tyson Foods Inc
Altria Group Inc
Lorillard Inc
Philip Morris International Inc
Reynolds American Inc
Clorox Co
Colgate-Palmolive Co
Kimberly-Clark Corp
Procter & Gamble Co/The
Avon Products Inc
Estee Lauder Cos Inc
Market
Capitalization
$47,127.4
$31,348.9
$17,635.2
$13,008.4
$8,603.6
$2,858.7
$6,931.7
$25,659.5
$189,658.6
$7,609.1
$8,223.8
$3,550.8
$118,582.4
$13,061.1
$9,301.8
$101,423.9
$16,249.9
$12,185.0
$10,773.6
$1,933.1
$23,632.5
$10,634.6
$13,971.3
$5,319.2
$6,578.0
$20,338.4
$49,863.6
$5,108.1
$10,086.9
$9,370.2
$6,627.1
$42,255.3
$10,927.6
$81,704.8
$15,196.3
Annual
Revenue
$98,729.0
$63,335.0
$36,853.3
$76,733.0
$40,850.7
$40,597.0
$8,031.6
$71,422.0
$408,214.0
$3,032.4
$2,481.0
$3,364.8
$30,990.0
$21,645.0
$5,531.0
$43,232.0
$69,207.0
$7,586.0
$12,731.2
$11,158.4
$14,691.3
$5,298.7
$10,495.0
$6,533.7
$3,757.9
$12,575.0
$40,386.0
$3,192.1
$2,826.5
$12,881.0
$26,704.0
$16,824.0
$3,686.0
$25,035.0
$8,419.0
$8,847.7
$38,229.5
$25,128.1
$175,933.3
$11,348.4
$11,620.8
$5,450.0
$15,327.0
$19,115.0
$79,029.0
$10,382.8
$7,323.8
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PepsiCo Company Report
As a defensive sector, consumer staples‟ performance is less sensitive to economic downturns
relative to other sectors. The consumer staples sector outperformed the S&P 500 over the last
two and three year periods ending in April 2010 which included the recent downturn. It lost
2.23% and gained 0.82% over the last two and three years, respectively, compared to a loss of
14.35% and 19.95% for the S&P 500 for the same periods, respectively. During 2010 when the
economy showed clear signs of recovery, it underperformed the S&P 500. The sector return was
4.71% versus 10.51% for the S&P 500 in the first quarter and a return of -1.56% versus 1.48%
for the S&P 500 for the month of April. 4
Table 5 S&P 500 Sector Performance
The consumer sector is in the mature stage of the lifecycle such that all the companies in the
sector pay out regular quarterly dividends. It currently has a dividend yield of 3.03%
Table 6 Dividend Yield by Sector
Sector
Energy
Materials
Industrials
Consumer Discretionary
Consumer Staples
Health Care
Financials
Information Technology
Telecommunication Services
Utilities
4
Dividend Yield %
2.36
1.9
2.22
1.42
3.03
2.07
1.14
0.94
6.17
4.62
Source: Standard and Poor’s
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PepsiCo Company Report
In terms of valuation multiples, the consumer staples sector multiples are undervalued relative to
their absolute historical multiples with current levels below their 22-year historical medians.
Similarly, the sector‟s current valuation multiples relative to the S&P 500 is below its historical
medians versus the index.
Table 7 Consumer Staples Valuation
Consumer Staples Absolute Valuation
Valuation Ratios
High
Low
Consumer Staples Valuation Relative to S&P 500
Median
Current
Valuation Ratios
High
Low
Median
Current
P/Trailing EPS
34.8
12.2
20
15.6
P/Trailing EPS
1.5
0.74
1.1
0.84
P/Forward EPS
35.2
12.1
18.2
14.6
P/Forward EPS
1.6
0.76
1.1
0.94
P/B
P/S
P/CF
8.4
2.1
22.5
2.6
0.6
8.6
5.3
1.2
13.8
3.4
0.8
11.6
P/B
P/S
P/CF
2.7
1.2
1.5
0.8
0.5
0.7
1.7
0.8
1.2
1.5
0.6
1.1
Food and Non-Alcoholic Beverage Industry
PepsiCo is classified under the soft drink industry. However, unlike its competitors in the soft
drink industry, it is not a pure play soft drink company. It has a large portfolio of snacks and
food products.
In 2009, retail sales from food and beverage stores totaled an estimated $575.8 billion, up by
0.38% from the previous year based on estimates by the US Department of Commerce.
Consumers spent an additional $459.5 billion at food services and drinking places such as
restaurants, up 0.29% from 2008.
The food industry is comprised of a wide variety of categories such as sugar and confectionary,
fruit and vegetable preserving which includes frozen food manufacturing, fruit and vegetable
canning, dairy products manufacturing to name a few. Discussion in this paper will be limited to
the snack food industry since PepsiCo has a dominant position in that industry through its FLNA
division. PepsiCo is a key player in the cereal industry. However, it only has an 8% share
through its Quaker Foods division. The industry is dominated by Kellogg with 34.2% market
share and General Mills with 31.2% market share.5
Snack Food Industry
The snack food industry is estimated to generate $25.8 billion in revenue. Frito Lay dominates
the industry with an estimated 51% of the market. The other key players have single digit share
of the market with ConAgra Foods a distant second with 6% market share.
Industry performance is influenced by agricultural commodity prices such as nuts, corn, sugar
and grains. It competes with products such as cereals and confectionery. Like the beverage
industry, consumers increased health consciousness affects the demand for its products.
5
Source: IBISWorld Industry Report 31191 – Snack Food Production in the US
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PepsiCo Company Report
Figure 5 Snack Food Industry Product Segmentation
The most popular snack food are chips whether potato, corn or other chips with 71.5% of the
market. The nuts and seeds segment is a distant second with 11.5% market share.
Companies in this industry have to continuously innovate and introduce new products to
stimulate sales. PepsiCo introduced a baked line of potato chips a few years ago and recently
added a kettle-cooked reduced fat chips line.
Snack foods are sold primarily through grocery wholesalers which account for 83.4% of the
market in 2009. These wholesalers sell to supermarkets and convenience stores. Manufacturer
sales directly to retailers account for only 13.4% of the market. However, this segment is
expected to increase since large retailers such as Wal-Mart can realize huge cost savings from
bypassing wholesalers and negotiating directly with the manufacturers.
Soft Drink Industry
The non-alcoholic beverage industry is dominated by carbonated soft drinks (CSDs) with
54.3% of industry revenue. However, the category‟s share of industry revenue has been falling
due to the shift in consumer preference to non-carbonated beverages. According to Beverage
Digest, the CSD category in the US last grew in 2004. Major industry players have turned their
focus to producing and marketing non-carbonated drinks. Another trend within the carbonated
soft drink segment is the slowing growth of diet CSDs which started in 2005.
Bottled water includes flavored waters which at times are enhanced with vitamins. The category
is estimated to account for 14.5% of the industry‟s production in 2008. During the economic
downturn, growth in the category slowed down as more consumers turned to tap water. This is a
competitive category due to the commodity nature of the product, resulting in lower prices
compared to other beverages.
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PepsiCo Company Report
The sports drinks, energy drinks and juice categories are viewed to have the greatest growth
potential since these provide consumers with additional benefits such as nourishment from
juices, faster hydration from sports drinks and increased alertness from energy drinks. Sports
drinks account for 8.4% of industry revenue with Gatorade as the leading brand in the category. 6
The energy drink segment which represents 14.4% of sales by the industry is dominated by Red
Bull. Other beverages include tea and soy-based drinks.
Product Segmentation
Other Sports drinks
8.40%
Ice 3.30%
1.50%
Fruit beverages
14.40%
Energy drinks
3.60%
Vending
machine
operators
11%
Bottled water
14.50%
Carbonated soft
drink
54.30%
Other
8%
Convenience
stores and gas
stations
12%
Market Segmentation
Food service
and drinking
places
20%
Export
1%
Supermarkets
and general
merchandisers
48%
Total $ 44.4 bn
Figure 6 Product and Market Segmentation
Supermarkets and general merchandisers is the largest market for the sale of soft drinks and
bottled water and is the major channel to reach the end consumers. This is followed by food
service and drinking places, which includes fast food, takeout restaurants, diners, full-service
restaurants and bars. During the economic downturn, consumers cut down on dining out
resulting in a decline in sales to this segment.
Coca-Cola has the largest share of the soft drink market with 35% market share and a market
capitalization of $118.582 billion. It is followed by PepsiCo with a market share of 27% and a
market capitalization of $101.424 billion. A distant third is Dr. Pepper Snapple Group with a
market share of 6.5% and a market capitalization of $9.302 billion.
Company Analysis
Fundamental Drivers
PepsiCo intends to expand its macro snack business by growing its business outside the US and
developing and introducing new products based on changing consumer tastes and catering to
local tastes.
The company announced recently that it will invest $2.5 billion in China in addition to the $1
billion it had committed in 2008. The investment will be used to build new manufacturing
facilities, increase research and development, increased agricultural development and building its
brands in the country. PepsiCo plans to open 10-12 new plants in China to manufacture soft
drinks, non-carbonated beverages and snacks and expand production lines in existing facilities.
In addition, it plans to build a research and development center in China to develop products for
6
Source: IBISWorld Industry Report 31211 – Soft Drink Production in the US
15
PepsiCo Company Report
all of Asia and broaden its portfolio to provide more food and beverage choices using
wholesome ingredients.
Due to heightened health awareness, and increasing obesity concerns, Americans are turning
away from snack foods high in fat and sodium. PepsiCo has responded to this trend by
expanding its portfolio of healthier snack foods. It has eliminated trans-fat from its chips snacks
by using corn oil and added a line of baked chips. It announced earlier this year that it is
developing a new “designer salt” that will reduce sodium in its potato chips products by 25% or
more without impact on taste. In 2008, Frito-Lay introduced a line of premium nuts through its
TrueNorth line as another option to health-conscious consumers. By rolling out new innovative
products and differentiating its brands, PepsiCo can shift the buying habits of price conscious
consumers to purchase its premium brands over store brands.
PepsiCo acquired its two largest bottlers in North America to grow its beverage business. In the
past few years Pepsi have launched and acquired a range of non-carbonated brands as demands
for carbonated beverages declined and consumers shifted its preference to sports drinks, energy
drinks, water, juices and tea. Smaller brands such as fortified water, juices, and energy drinks
which are sold at relatively low volumes, do not have the economies of scale that bottlers found
attractive to distribute since the industry‟s operating margins are low. The acquisitions provide
PepsiCo the flexibility in getting its products to market faster and more efficiently. In addition,
large retail store chains such as Wal-Mart and Kroger have been demanding customized route to
market. By vertically integrating, PepsiCo eliminates any profitability conflicts that can exist
between two companies. It then enables PepsiCo to be more responsive to the demands of both
retailers and end consumers.
The buying power of retailers has increased over the past decade due to the consolidation in the
industry. With its extensive portfolio of snacks, food and beverage products PepsiCo increases
its bargaining power over the retailers in terms of pricing and shelf space. PepsiCo has the first
mover advantage in the industry shift to vertically integrate the bottlers and had started realizing
the synergies of the combined companies. Coca Cola is yet to close on its acquisition of Coca
Cola Enterprises which is expected in the Fall of 2010.7
PepsiCo‟s plans to expand its “good for you” portfolio which currently generates $10 billion in
revenue from its core products led by Tropicana, Lebedyansky, Pandora in the juice brands,
Aquafina, Quaker for grains, G, Gatorade for athletes and the new dairy joint venture with
Almarai. PepsiCo intends to expand this to a $30 billion dollar portfolio by investing in R&D to
find science-based innovations and through targeted acquisitions and joint ventures.
Financial Analysis
PepsiCo revenue is estimated to increase between eight to nine percent driven by growth in its
snack food business and regional growth in its emerging markets segment, AMEA. Prior to the
7
Morningstar Stock Strategist Industry Reports – Coke Rises to the Pepsi Challenge by Philip Gorham, CFA, April
14, 2010
16
PepsiCo Company Report
economic downturn PepsiCo revenue was growing at an average of 9% year over year for the six
years prior to the recent recession. The sharp increase in revenue between fiscal year 2009 and
2010 in the proforma income statement shown in Table 8 is due to revenues from the two
bottlers acquired in February which are now going to be reflected in PepsiCo‟s consolidated
financial statements. Operating income improvements of around 6% year over year is expected
as PepsiCo continues its cost management initiatives and improves efficiency. Operating margin
is 18% consistent with the company‟s experience.
Table 8 PepsiCo Proforma Income Statement
(Millions)
FY
FY
FY
FY
FY
FY
FY
FY
2012E
2011E
2010E
2009
2008
2007
2006
2005
Net Sales
67,100
61,260
56,661
43,232
43,251
39,474
35,137
32,562
Operating Expenses
55,108
50,164
46,111
35,188
36,292
32,292
28,635
26,578
Operating Income
11,992
11,096
10,549
8,044
6,959
7,182
6,502
5,984
Interest expense and Income
Bottling Equity Income
Interest Expense
Interest Income
Total
Inc before inc taxes & minority interest
Provision for Income taxes
Net Income
Less: Net Income attributable to noncontrolling interest
(805)
(735)
365
374
560
553
495
(680)
(397)
(329)
(224)
(239)
(256)
121
110
102
67
41
125
173
159
(684)
(625)
(578)
35
86
461
487
398
11,307
10,471
9,971
8,079
7,045
7,643
6,989
6,382
3,392
3,141
2,792
2,100
1,879
1,973
1,347
2,304
7,915
7,329
7,179
5,979
5,166
5,670
5,642
4,078
-
-
-
-
-
Net Income
7,915
7,329
7,179
5,946
5,142
5,658
5,642
4,078
Common Shares
1,453
1,553
1,653
1,584
1,568
1,618
1,642
1,659
5.45
4.72
4.34
3.81
3.26
3.48
3.42
2.43
-
-
-
-
-
-
-
-
5.45
4.72
4.34
3.81
3.26
3.48
3.42
2.43
1,453
1,553
1,653
1,584
1,597
1,639
1,681
1,700
5.45
4.72
4.34
3.71
3.21
3.41
3.34
2.39
-
-
-
-
-
-
-
-
5.45
4.72
4.34
3.71
3.21
3.41
3.34
2.39
EPS-Basic (pre acct chnge)
Cumul effect of acct change
Net Income
Diluted Shares
EPS-diluted
Cumul effect of acct change
Net Income
(33)
(24)
(12)
Profitability
PepsiCo has been consistently profitable with profit margins consistently above 10% in this
decade and a return of over 30% to its common equity holders for most the decade.
17
PepsiCo Company Report
Table 9 PepsiCo Profitability Ratios
FY 2009
FY 2008
FY 2007
FY 2006
FY 2005
FY 2004
FY 2003
FY 2002
FY 2001
FY 2000
Gross Margin
Operating Margin
Pretax Margin
Profit Margin
Return on Assets
Return on Common Equity
Return on Capital
53.51
18.61
18.69
13.75
15.67
41.24
27.49
52.95
16.03
16.23
11.89
14.56
35.14
25.45
54.30
18.16
19.33
14.33
17.52
34.78
29.01
55.14
18.52
19.89
16.06
18.27
38.13
31.00
56.46
18.19
19.60
12.52
13.65
29.43
23.29
54.18
18.49
18.95
14.39
15.79
33.25
27.86
54.10
18.49
18.51
13.23
14.61
33.45
27.87
54.22
18.00
17.65
11.95
13.27
33.05
26.06
54.28
18.75
17.14
11.32
12.52
32.71
24.93
61.14
15.78
15.71
10.68
11.40
30.14
22.48
Effective Tax Rate
25.99
26.76
25.86
19.27
36.10
24.74
28.53
32.33
33.93
31.99
Earnings per share (EPS) has been growing above 10% year over year during the decade except
for years during a recession. EPS long-term future growth rate is expected to be 9%.
Table 10 PepsiCo Earnings Per Share
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010 2011E
0.53
0.70
0.42 0.49 0.52 0.58 0.66 0.78
0.39 0.44 0.44 0.52 0.58 0.65
0.60
0.80
0.88
0.72
0.65
0.94
0.99
0.80
0.70
1.03
1.06
0.88
0.71
1.02
1.08
0.90
0.76
1.09
1.24
1.09
March
0.28
0.33
0.35
0.39
0.46
June
0.33
0.46
0.48
0.54
0.61
September
December
0.84
1.25
1.34
1.22
Year
1.42
1.72
1.79
2.03
2.31
2.66
3.00
3.38
3.67
3.71
4.16
4.64
Year over Year
15%
21%
4%
13%
14%
15%
13%
13%
9%
1%
12%
12%
Coca-Cola margins are higher compared to PepsiCo. During the decade, its gross margin has
been above 60% and its profit margin approximately 20%. However, its return ratios are
comparable to PepsiCo.
Table 11 Coca-Cola Profitability Ratios
FY 2009
FY 2008
FY 2007
FY 2006
FY 2005
FY 2004
FY 2003
FY 2002
FY 2001
FY 2000
Gross Margin
64.22
64.39
63.99
66.12
64.33
64.70
63.12
63.68
65.55
68.81
Operating Margin
26.56
26.44
26.06
27.39
26.13
26.21
27.53
27.90
30.50
25.81
Pretax Margin
28.87
23.29
27.28
27.31
28.96
28.62
26.11
28.11
32.32
17.09
Profit Margin
22.02
18.18
20.73
21.09
21.09
22.29
20.66
15.59
22.62
10.95
Return on Assets
15.30
13.86
16.33
17.11
16.01
16.49
16.77
13.00
18.35
10.26
Return on Common Equity
30.15
27.51
30.94
30.53
30.18
32.29
33.58
26.33
38.38
23.12
Return on Capital
21.31
19.87
23.78
24.11
22.35
23.46
24.48
18.99
26.53
16.04
Effective Tax Rate
22.80
21.94
24.03
22.77
27.17
22.10
20.89
27.70
29.82
35.95
Coca-Cola‟s EPS has been more volatile than PepsiCo during this decade with more years in
single digit growth. It experienced a negative 3% EPS growth during the latest recession in 2009.
For the same year, PepsiCo‟s EPS was still positive at 1%. This is due to PepsiCo‟s FLNA and
AMEA growth during the year. Long-term EPS growth is lower than PepsiCo at 8%.
18
PepsiCo Company Report
Table 12 Coca-Cola Earnings Per Share
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
March
0.22
0.35
0.34
0.37
0.46
0.47
0.49
0.56
0.67
0.65
0.8
0.87
June
0.42
0.45
0.49
0.57
0.65
0.68
0.74
0.85
1.01
0.92
1.02
1.12
September
0.42
0.41
0.45
0.55
0.5
0.57
0.62
0.71
0.83
0.82
0.89
0.98
December
0.38
0.37
0.38
0.46
0.46
0.46
0.52
0.58
0.64
0.66
0.73
0.80
Year
1.44
1.58
1.66
1.95
2.07
2.18
2.37
2.7
3.15
3.05
3.45
3.75
Year to Year
12%
10%
5%
17%
6%
5%
9%
14%
17%
-3%
13%
9%
Dr Pepper Snapple Group (DPS) financial data as a publicly traded company started in 2008
when it was spun off by Cadbury Schweppes. It is the smallest soft drink manufacturer in the
index. DPS profitability ratios and returns are either similar to PepsiCo‟s or lower. Long-term
estimated EPS growth is lower at 8%.
Table 14 Comparative Profitability Ratios
Table 13 Comparative EPS 2009
PepsiCo
Coca-Cola
DPS
Kraft
General
Mills
DPS
Gross Margin
53.51
64.22
59.61
36.15
35.62
Operating Margin
18.61
26.56
19.62
13.53
15.52
Year
Pretax Margin
18.69
28.87
15.69
10.62
13.78
Profit Margin
13.75
22.02
10.03
7.48
Return on Assets
15.67
15.30
6.37
Return on Common Equity
41.24
30.15
Return on Capital
27.49
21.31
Effective Tax Rate
25.99
22.80
Kraft
General
Mills*
1.97
2.04
3.98
Year to Year
7%
8%
10%
8.88
L/T Growth rate
8%
8%
9%
4.65
7.07
* Fiscal year 2008-2009
19.16
12.54
22.90
11.53
8.95
12.09
36.29
29.37
35.58
Kraft and General Mills are included in the comparison with PepsiCo since both these companies
are PepsiCo‟s competitors in the snack food and cereal industries. Kraft and General Mills have
lower margins and returns compared to PepsiCo and the soft drink industry in general.
Liquidity
PepsiCo‟s liquidity position has been consistently strong as shown by several liquidity
measurement ratios. Its cash, quick and current ratios have been improving over time which
means that its ability to meet its short-term debt obligations has been strengthening. With its
current quick ratio PepsiCo‟s more liquid current assets (cash, short-term investments and
receivables), can meet its entire current liabilities.
On the other hand, its cash conversion cycle metrics which measures the number of days that the
company‟s cash is tied up in inventory and sales process has been increasing. Its inventory
turnover days increased from 40 days in 2004 to 46 in the last fiscal year, its inventory to cash
days increased from 75 in 2001 to 85 in 2009 and its accounts receivable turnover days increased
from 33 days in 2001 to 39 days in the last fiscal year.
19
PepsiCo Company Report
PepsiCo‟s working capital has been increasing over the years and stood at $3.8 billion by the end
of 2009. However, its cash flow from operations as a percentage of total debt has been declining.
Table 15 PepsiCo Liquidity Ratios
FY 2009 FY 2008 FY 2007 FY 2006 FY 2005 FY 2004 FY 2003 FY 2002 FY 2001 FY 2000
Cash Ratio
Quick Ratio
Current Ratio
Total Debt/Total Capital
Cash & Equivalents/Current Assets
Accounts Receivable Turnover-Days
Inventory Turnover Days
Inventory to Cash Days
CFO/Total Debt
Cashflow/Total Liabilities
Working Capital (MM)
0.47
0.26
0.32
0.41
0.52
0.51
1.00
0.79
0.89
0.95
0.87
0.95
1.44
1.23
1.31
1.33
1.11
1.28
31%
40%
22%
16%
27%
20%
33%
21%
24%
31%
47%
40%
39
39
37
36
36
36
46
44
43
42
42
40
85
82
80
78
78
76
86%
85% 147% 215% 113% 146%
30%
29%
40%
42%
33%
35%
$3,815 $2,019 $2,398 $2,270 $1,048 $1,887
0.31
0.75
1.08
16%
29%
36
40
77
189%
32%
$515
0.30
0.72
1.06
22%
29%
34
42
76
168%
33%
$361
0.33
0.76
1.17
26%
28%
33
42
75
127%
29%
$855
0.31
0.76
1.17
30%
27%
35
49
84
138%
34%
$822
PepsiCo has the strongest liquidity ratios in terms of its cash, quick and current ratios compared
to its competitors. In terms of cash conversion cycle metrics, Dr Pepper Snapple has the shortest
turnover days to convert inventory to sales and inventory to cash.
Table 16 Comparative Liquidity Ratios FY 2009
PepsiCo
Cash Ratio
Quick Ratio
Current Ratio
Total Debt/Total Capital
Cash & Equivalents/Current Assets
Accounts Receivable Turnover-Days
Inventory Turnover Days
Inventory to Cash Days
CFO/Total Debt
Cashflow/Total Liabilities
Working Capital (MM)
0.47
1.00
1.44
31%
33%
39
46
85
86%
30%
$3,815
Coca-Cola
0.67
0.95
1.28
32%
52%
40
75
115
68%
35%
$3,830
Dr. Pepper
Snapple
0.33
0.96
1.5
48%
22%
35
43
78
29%
15%
$425
Kraft
0.18
0.64
1.08
42%
17%
45
54
99
27%
12%
$963
General
Mills
0.21
0.47
0.98
57%
21%
26
53
79
26%
15%
-$71
20
PepsiCo Company Report
Leverage
Total debt is calculated by adding short-term debt to long-term debt obligations. PepsiCo‟s total
debt is mostly composed of its long term debt starting in 2006 since leverage ratios using long
term debt and total debt were not a lot different during those years. This is confirmed by
calculating the percentage of long-term debt to total debt. Long-term debt has been over 90% of
total debt during that period. In 2005, long-term debt was only 44% of its total debt. PepsiCo‟s
leverage ratios peaked in 2008 and showed a sharp improvement in 2009 and are now less than
half of common equity.
Table 17 PepsiCo Leverage Ratios
FY 2009 FY 2008 FY 2007 FY 2006 FY 2005 FY 2004 FY 2003 FY 2002 FY 2001 FY 2000
LT Debt/Common Equity
LT Debt/Total Capital
LT Debt/Total Assets
44.1%
29.2%
18.6%
65.1%
38.6%
21.8%
24.4%
19.1%
12.1%
16.6%
14.0%
8.5%
16.3%
11.9%
7.3%
17.8%
14.1%
8.6%
14.4%
12.0%
6.7%
23.1%
17.8%
9.3%
30.7%
22.7%
12.2%
39.6%
27.8%
14.5%
Total Debt/Common Equity
Total Debt/Total Equity
Total Debt/Total Capital
Total Debt/Total Assets
Total Debt/Market Cap
46.9%
45.1%
31.1%
19.7%
8.2%
68.2%
68.0%
40.5%
22.9%
9.7%
27.5%
27.4%
21.5%
13.7%
3.8%
18.4%
18.4%
15.5%
9.4%
2.8%
36.6%
36.5%
26.7%
16.4%
5.3%
25.6%
25.5%
20.3%
12.3%
4.0%
19.4%
19.3%
16.2%
9.1%
2.9%
29.0%
28.9%
22.4%
11.7%
3.8%
34.7%
34.6%
25.7%
13.9%
3.5%
42.2%
42.1%
29.6%
15.5%
3.7%
Dr Pepper Snapple and General Mills have high leverage compared to the other companies.
Coca-Cola‟s short-term debt must be a significant part of its total debt since its leverage using
long-term debt looks much better than when total debt is used. PepsiCo and Coca-Cola,
currently, have similar leverage ratios when using total debt to calculate leverage.
Table 18 Comparative Leverage Ratios FY 2009
PepsiCo
Coca-Cola
DPS
Kraft
General
Mills
LT Debt/Common Equity
LT Debt/Total Capital
LT Debt/Total Assets
44.1%
29.2%
18.6%
20.4%
13.6%
10.4%
92.9%
48.2%
33.7%
69.7%
40.1%
27.0%
111.2%
46.1%
32.2%
Total Debt/Common Equity
Total Debt/Total Equity
Total Debt/Total Capital
Total Debt/Total Assets
Total Debt/Market Cap
46.9%
45.1%
31.1%
19.7%
8.2%
47.8%
46.8%
31.9%
24.4%
9.0%
92.9%
92.9%
48.2%
33.7%
41.0%
73.4%
73.1%
42.2%
28.5%
47%
136.7%
130.3%
56.6%
39.6%
42%
21
PepsiCo Company Report
Company Valuation
PepsiCo‟s current valuation ratios are lower than their 22-year medians on an absolute basis. I
used each of the ratios to calculate a target price for PepsiCo. Assuming the these multiples are
going to move towards their long-term medians, I arrived at an average and median target price
of $75 for PepsiCo.
Table 19 Target Price Based on Valuation Multiples
Valuation Ratio
High
P/Forward E
P/S
P/B
P/EBITDA
P/CF
Low
Median
Current
Target
Multiple
Target
Metric
Value
Target Price
32.5
13.1
20.7
15.1
17.8
4.16
74.05
3.6
10.6
16.79
0.9
3.3
5.49
2.2
6.7
11.91
2.4
6.1
10.23
2.2
6.4
11
34.28
11.51
7.25
75.42
73.66
79.75
24.9
8.1
16.5
13.6
14.5
5.16
74.82
Average
Median
75.54
74.82
PepsiCo valuation is in line with the Soft Drink industry. Its current valuations are only slightly
more expensive or cheaper relative to the industry and the historical medians. In terms of current
relative valuation to the S&P 500, PepsiCo is undervalued on the basis of both price-to-earnings
ratios and overvalued on P/B, P/S and P/CF.
Table 21 PepsiCo Valuation Relative to the Soft Drink Industry
Valuation Ratio
High
Low
Median
Table 20 PepsiCo Valuation Relative to S&P 500
Valuation Ratio
Current
P/Trailing E
1.2
0.64
0.94
0.98
P/Trailing E
P/Forward E
1.1
0.64
0.97
0.97
P/B
P/S
P/CF
1.6
1.3
1.3
0.1
0.4
0.3
0.7
0.7
1.1
1.1
1.1
1
High
Low
Median
Current
2
0.88
1.3
0.92
P/Forward E
1.4
0.85
1.2
0.97
P/B
P/S
P/CF
4.3
2.6
2
1.4
1
1
2.3
1.8
1.6
2.6
1.8
1.3
22
PepsiCo Company Report
Coca-Cola Enterprises is in the process of being acquired by Coca-Cola. I included the company
in the figure below since its valuation is still reflected in the industry level valuations. Current
valuations of Dr Pepper Snapple are lower than the soft drink industry valuations. Coca-Cola is
expensive relative to PepsiCo in all measures below except trailing P/E. Kraft and General mills
have valuations comparative to PepsiCo in terms of forward P/E and P/CF and less expensive in
all other measures.
Table 22 Comparative Company Valuations
Name
Soft Drinks
Coca-Cola Co/The
Coca-Cola Enterprises Inc
Dr Pepper Snapple Group Inc
PepsiCo Inc/NC
Soft Drinks Valuation
Packaged Foods & Meats
Campbell Soup Co
ConAgra Foods Inc
Dean Foods Co
General Mills Inc
Hershey Co/The
HJ Heinz Co
Hormel Foods Corp
JM Smucker Co/The
Kellogg Co
Kraft Foods Inc
McCormick & Co Inc/MD
Mead Johnson Nutrition Co
Sara Lee Corp
Tyson Foods Inc
Packaged Foods & Meats Valuation
Trailing
P/E
Forward
P/E
Price to
Book
Price to
Sales
Price to
Cashflow
17.00
17.50
17.00
17.20
17.50
15.50
16.00
14.10
15.10
15.60
5.00
16.00
2.70
6.10
5.40
4.00
0.60
1.50
2.40
2.10
14.50
7.50
11.70
13.60
13.90
15.00
14.30
10.20
15.00
19.80
16.60
14.60
14.40
17.10
14.80
16.40
23.70
14.20
20.70
15.80
14.20
11.90
13.50
2.20
10.60
2.20
15.00
3.70
14.50
13.80
15.60
8.10
14.90
2.40
15.00
1.40
15.10
9.10
14.60
1.70
15.40
4.00
22.30 NM
13.10
3.40
13.00
1.60
15.20
2.80
1.60
0.90
0.30
1.60
2.00
1.40
0.80
1.60
1.60
1.30
1.60
3.80
0.80
0.30
0.90
11.40
10.00
5.40
11.50
14.90
12.50
10.90
10.70
12.90
11.70
12.50
21.00
8.40
8.80
11.50
23
PepsiCo Company Report
Discounted Cash Flow (DCF) Analysis
Unlike valuation metrics such as the P/E ratio, DCF relies on free cash flows. It is a more reliable
estimate of a company‟s intrinsic value since it removes the accounting arbitrariness in
recognizing earnings and expenses. Regardless of whether a cash outlay is expensed or
capitalized, free cash flow is the money left over for investors.
A discount rate of 9.5% is used in the DCF model which the rate used for less risky defensive
sectors such as consumer staples. There is no indication from my research that PepsiCo is riskier
than the sector and that a higher rate is warranted. A growth rate of 4% is used assuming that the
company‟s long-term growth rate would be that of the market. The following are other
assumptions used in the construction of the model:






Revenue for the company for 2010 to 2012 is 8% on average reflecting the revenue growth
expectations for its business units. An average of 3.5% revenue growth for PAB, the
beverage unit, reflecting the below market growth of the beverage industry, an average 18%
growth for PepsiCo International as this business has been experiencing this type of double
digit growth which is expected to continue given that PepsiCo plans to expand its
international operations and an average of 6% growth for above market growth expectation
for its food and snacks unit, PAF.
Operating Income is projected at an average of 18% in the next three years as a result of
rolling up the projected revenues and operating costs of its three business units and is
consistent with the company‟s experience during the decade.
Interest Expense is based on the company‟s experience in the previous five fiscal years and
increasing to 1.2% of revenue as the economy grows and interest rates increase.
Depreciation is based on its historical relationship to revenue.
Tax for the current fiscal year is 28% based on the company‟s guidance during its earnings
call for its fiscal 2009 performance. The tax rate is projected to increase to 30% given the
deficits experienced by the countries in which PepsiCo operates.
Capital Expenditure for the current fiscal year is based on the company‟s planned $3.6 billion
spending on this item, moving towards its historical rate relative to sales and finally
converging with the terminal depreciation rate.
24
PepsiCo Company Report
Table 23 PepsiCo Discounted Cash Flow Model
Year
2009A
Terminal Discount Rate =
9.5%
Terminal FCF Growth =
4.0%
2010E
2011E
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
Revenue
43,232
56,661
61,260
67,100
71,126
75,038
79,165
83,123
87,280
91,207
94,855
% Grow th
-0.04%
31.1%
8.1%
9.5%
6.0%
5.5%
5.5%
5.0%
5.0%
4.5%
4.0%
8,044
10,549
11,096
11,992
12,447
13,132
13,854
14,547
15,274
15,961
16,600
18.6%
18.6%
18.1%
17.9%
17.5%
17.5%
17.5%
17.5%
17.5%
17.5%
17.5%
Operating Income
Operating Margin
Interest and Other
Interest % of Sales
Taxes
Tax Rate
Net Income
35
(578)
(625)
(684)
(854)
(900)
(950)
(997)
(1,047)
(1,094)
(1,138)
0.1%
-1.0%
-1.0%
-1.0%
-1.2%
-1.2%
-1.2%
-1.2%
-1.2%
-1.2%
-1.2%
2,100
2,792
3,141
3,803
3,990
4,210
4,441
4,663
4,896
5,117
5,321
26.0%
28.0%
30.0%
30.0%
30.0%
30.0%
30.0%
30.0%
30.0%
30.0%
30.0%
5,946
7,179
7,329
7,504
7,573
7,992
8,433
8,856
9,300
9,720
10,110
20.7%
2.1%
2.4%
0.9%
5.5%
5.5%
5.0%
5.0%
4.5%
4.0%
1,635
2,266
2,450
2,684
2,703
2,851
3,008
3,159
3,317
3,466
3,605
3.8%
4.0%
4.0%
4.0%
3.8%
3.8%
3.8%
3.8%
3.8%
3.8%
3.8%
(183)
277
33
47
(71)
(75)
(79)
(83)
(87)
(91)
(95)
-0.4%
0.5%
0.1%
0.1%
-0.1%
-0.1%
-0.1%
-0.1%
-0.1%
-0.1%
-0.1%
2,128
3,598
3,369
3,355
3,556
3,602
3,642
3,657
3,666
3,648
3,605
4.9%
6.4%
5.5%
5.0%
5.0%
4.8%
4.6%
4.4%
4.2%
4.0%
3.8%
5,270
6,124
6,444
6,880
6,649
7,166
7,720
8,274
8,864
9,446
10,015
16.2%
5.2%
6.8%
-3.4%
7.8%
7.7%
7.2%
7.1%
6.6%
6.0%
Terminal Value
189,378
% Grow th
Add Depreciation/Amort
% of Sales
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
Free Cash Flow
% Grow th
NPV of Cash Flows
46,750
NPV of terminal value
76,417
62%
Projected Equity Value
123,167
100%
Free Cash Flow Yield
Current P/E
Projected P/E
Current EV/EBITDA
Projected EV/EBITDA
Shares Outstanding
38%
5.07%
Free Cash Yield
17.5
14.5
14.2
20.7
17.2
16.8
11.1
8.4
7.9
13.1
9.9
9.3
5.29%
Terminal P/E
18.7
Terminal EV/EBITDA
9.5
1,653
Current Price
$ 62.89
Debt
7,400
Implied equity value/share
$ 74.51
Cash
3,943
Cash/Share
2.39
Upside/(Downside) to DCF
18.5%
25
PepsiCo Company Report
Risks





There is the risk of missteps in integrating the two bottlers, the Pepsi Bottling Group, Inc.
(PBG) and PepsiAmericas, Inc. (PAS) preventing the company to fully realize the benefits
and cost savings expected from the acquisitions.
Currency risk increases as PepsiCo derives a greater proportion of its revenue from its
international operations.
PepsiCo operates in 200 countries exposing it to political risk. A recent example of such risk
occurred in early May when Venezuelan President Hugo Chavez seized a warehouse owned
by Empresas Polar SA, the country‟s largest food maker, which has a joint venture with
PepsiCo for the last 15 years to supply carbonated drinks in Venezuela.8
Increasing commodity prices will affect PepsiCo‟s performance since it is dependent on
agricultural commodity products. Prices are dependent on global demand and supply and are
sensitive to extreme weather conditions.
The impact of the European debt crisis could slow down the global economic growth which
can have an adverse effect on PepsiCo‟s future revenue.
Conclusion
PepsiCo is a well managed company with well defined strategies to achieve growth in a mature
industry. From recent events and announcements, it seems that the company is making progress
executing on these strategies. It seeks to derive growth by expanding its operations
internationally which is evident in its recent announcement that it is investing $2.5 billion in
China, the fastest growing economy in the world. The company is leading the way in innovation
through R&D and its focus on health and nutrition in developing its products.
I have a buy recommendation on PepsiCo. Based on the discounted cash flow (DCF) model, the
target price for PepsiCo is $74 for the next year. This is a price appreciation of 18.5% on the
current price of $ 62.89, the closing price on May 28. With an additional 2.94% dividend yield,
total return is estimated to be 21.4%.
8
Source: Venezuelan Pepsi Seizure May Cut Supply, Montoya Says”, May 4, 2010, Bloomberg.com
26