pepsico, inc. - max m. fisher college of business · pdf filepepsico, inc. completed its $ 7.8...

PepsiCo, Inc.

(NYSE: PEP)

Price Target: $74.00

Recommendation: BUY

Report Date: June 1, 2010

Fund: Ohio State University SIM Fund

Fund Manager: Chris Henneforth, CFA

Royce West, CFA

Analyst: Lourdes R. Dudaney

Fisher College of Business

The Ohio State University

Columbus, Ohio

[email protected], 614.354.6578

Investment Thesis

PepsiCo is one of the largest consumer products companies

manufacturing and selling a wide range of snacks, non-

alcoholic 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.

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.

Sector Consumer Staples

Industry Food and Non-Alcoholic Beverage

Market Data

Current Price 62.89

52-week high (05/12/2010) 67.61

52-week low (05/29/2009) 50.85

Average Daily Volume 7,806,765

Market Capitalization (MM) $101,424

Shares Outstanding (MM) 1,612.72

Dividend Yield (Annual) 2.864

Financial Summary

EV/EBITDA 12.61

Book Value/Share 13.34

Total Debt (MM) 21,858

Return on Equity 41.24%

Long-Term Debt (MM) 19,884

Figure 1 12-month Price Performance Graph

Table 1 Highlights of Stock Performance

PepsiCo Company Report

1

TABLE OF CONTENTS

COMPANY OVERVIEW 3

PEPSICO BUSINESS UNITS 3

INGREDIENTS AND OTHER SUPPLIES 5

CUSTOMERS 5

DISTRIBUTION NETWORK 5

COMPETITIVE ADVANTAGE 6

MACROECONOMIC ANALYSIS 6

COMMODITY PRICES 9

DEMOGRAPHIC TRENDS 10

CONSUMER STAPLES SECTOR 10

FOOD AND NON-ALCOHOLIC BEVERAGE INDUSTRY 13

SNACK FOOD INDUSTRY 13

SOFT DRINK INDUSTRY 14

COMPANY ANALYSIS 15

FUNDAMENTAL DRIVERS 15

FINANCIAL ANALYSIS 16

LIQUIDITY 19

LEVERAGE 21

COMPANY VALUATION 22

DISCOUNTED CASH FLOW (DCF) ANALYSIS 24

RISKS 26

CONCLUSION 26


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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


3

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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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.

Figure 2 Net Revenue and Operating Income Breakdown

FLNA31%

QFNA4%

LAF13%

PAB23%

Europe16%

AMEA13%

Net Revenue by Segment

PepsiCo Americas

Foods

(PAF) 48%

PepsicCo Americas

Beverages

(PAB)23%

PepsiCo International

29%

Net Revenue by Business Unit

FLNA38%

QFNA7%

LAF11%

PAB25%

Europe11%

AMEA8%

Operating Income by Segment

PepsiCo Americas

Foods (PAF)

56%PepsicCo Americas

Beverages

(PAB)25%

PepsiCo International

19%

Operating Income by Business Unit


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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, fixed-

price 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


6

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.


7

Figure 3 Macroeconomic Factors Relevant to PepsiCo


8

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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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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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

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.

Year 2010 Year 2030

Age Population

Percent of

Population Age Population

Percent of

Population

0-14 62,380,610 20% 0-14 72,959,056 19.5%

15-64 207,623,541 67% 15-64 228,452,703 61.2%

65-99 40,228,712 13% 65-99 72,091,915 19.3%

Total 310,232,863 100% Total 373,503,674 100%


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Table 4 Consumer Staples Sector Industries and Companies

Industry Group Industry Sub-Industry CompaniesMarket

Capitalization

Annual

Revenue

Food & Staples Retailing Food & Staples Retailing Drug Retail CVS Caremark Corp $47,127.4 $98,729.0

Walgreen Co $31,348.9 $63,335.0

Food Distributors Sysco Corp $17,635.2 $36,853.3

Food Retail Kroger Co/The $13,008.4 $76,733.0

Safeway Inc $8,603.6 $40,850.7

SUPERVALU Inc $2,858.7 $40,597.0

Whole Foods Market Inc $6,931.7 $8,031.6

Hypermarkets & Super Centers Costco Wholesale Corp $25,659.5 $71,422.0

Wal-Mart Stores Inc $189,658.6 $408,214.0

Food, Beverage & Tobacco Beverages Brewers Molson Coors Brewing Co $7,609.1 $3,032.4

Distillers & Vintners Brown-Forman Corp $8,223.8 $2,481.0

Constellation Brands Inc $3,550.8 $3,364.8

Soft Drinks Coca-Cola Co/The $118,582.4 $30,990.0

Coca-Cola Enterprises Inc $13,061.1 $21,645.0

Dr Pepper Snapple Group Inc $9,301.8 $5,531.0

PepsiCo Inc/NC $101,423.9 $43,232.0

Food Products Agricultural Products Archer-Daniels-Midland Co $16,249.9 $69,207.0

Packaged Foods & Meats Campbell Soup Co $12,185.0 $7,586.0

ConAgra Foods Inc $10,773.6 $12,731.2

Dean Foods Co $1,933.1 $11,158.4

General Mills Inc $23,632.5 $14,691.3

Hershey Co/The $10,634.6 $5,298.7

HJ Heinz Co $13,971.3 $10,495.0

Hormel Foods Corp $5,319.2 $6,533.7

JM Smucker Co/The $6,578.0 $3,757.9

Kellogg Co $20,338.4 $12,575.0

Kraft Foods Inc $49,863.6 $40,386.0

McCormick & Co Inc/MD $5,108.1 $3,192.1

Mead Johnson Nutrition Co $10,086.9 $2,826.5

Sara Lee Corp $9,370.2 $12,881.0

Tyson Foods Inc $6,627.1 $26,704.0

Tobacco Tobacco Altria Group Inc $42,255.3 $16,824.0

Lorillard Inc $10,927.6 $3,686.0

Philip Morris International Inc $81,704.8 $25,035.0

Reynolds American Inc $15,196.3 $8,419.0 Household & Personal

Products Household Products Household Products Clorox Co $8,847.7 $5,450.0

Colgate-Palmolive Co $38,229.5 $15,327.0

Kimberly-Clark Corp $25,128.1 $19,115.0

Procter & Gamble Co/The $175,933.3 $79,029.0

Personal Products Personal Products Avon Products Inc $11,348.4 $10,382.8

Estee Lauder Cos Inc $11,620.8 $7,323.8


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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

4 Source: Standard and Poor’s

Sector Dividend Yield %

Energy 2.36

Materials 1.9

Industrials 2.22

Consumer Discretionary 1.42

Consumer Staples 3.03

Health Care 2.07

Financials 1.14

Information Technology 0.94

Telecommunication Services 6.17

Utilities 4.62


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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

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

Consumer Staples Absolute Valuation Consumer Staples Valuation Relative to S&P 500

Valuation Ratios High Low 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 8.4 2.6 5.3 3.4 P/B 2.7 0.8 1.7 1.5

P/S 2.1 0.6 1.2 0.8 P/S 1.2 0.5 0.8 0.6

P/CF 22.5 8.6 13.8 11.6 P/CF 1.5 0.7 1.2 1.1


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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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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.

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

Bottled water

14.50%

Carbonated soft

drink

54.30%Energy drinks

3.60%

Fruit beverages

14.40%

Ice

1.50%

Other

3.30%

Sports drinks

8.40%

Product Segmentation

Total $ 44.4 bn

Supermarkets and general

merchandisers

48%Food service and drinking

places

20%

Convenience stores and gas

stations

12%

Vending machine

operators

11%

Other8%

Export1%

Market Segmentation


16

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


17

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

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.

FY FY FY FY FY FY FY FY

(Millions) 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 365 374 560 553 495

Interest Expense (805) (735) (680) (397) (329) (224) (239) (256)

Interest Income 121 110 102 67 41 125 173 159

Total (684) (625) (578) 35 86 461 487 398

Inc before inc taxes & minority interest 11,307 10,471 9,971 8,079 7,045 7,643 6,989 6,382

Provision for Income taxes 3,392 3,141 2,792 2,100 1,879 1,973 1,347 2,304

Net Income 7,915 7,329 7,179 5,979 5,166 5,670 5,642 4,078

Less: Net Income attributable to noncontrolling interest - - - (33) (24) (12) - -

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

EPS-Basic (pre acct chnge) 5.45 4.72 4.34 3.81 3.26 3.48 3.42 2.43

Cumul effect of acct change - - - - - - - -

Net Income 5.45 4.72 4.34 3.81 3.26 3.48 3.42 2.43

Diluted Shares 1,453 1,553 1,653 1,584 1,597 1,639 1,681 1,700

EPS-diluted 5.45 4.72 4.34 3.71 3.21 3.41 3.34 2.39

Cumul effect of acct change - - - - - - - -

Net Income 5.45 4.72 4.34 3.71 3.21 3.41 3.34 2.39


18

Table 9 PepsiCo Profitability Ratios

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

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

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%.

FY 2009 FY 2008 FY 2007 FY 2006 FY 2005 FY 2004 FY 2003 FY 2002 FY 2001 FY 2000

Gross Margin 53.51 52.95 54.30 55.14 56.46 54.18 54.10 54.22 54.28 61.14

Operating Margin 18.61 16.03 18.16 18.52 18.19 18.49 18.49 18.00 18.75 15.78

Pretax Margin 18.69 16.23 19.33 19.89 19.60 18.95 18.51 17.65 17.14 15.71

Profit Margin 13.75 11.89 14.33 16.06 12.52 14.39 13.23 11.95 11.32 10.68

Return on Assets 15.67 14.56 17.52 18.27 13.65 15.79 14.61 13.27 12.52 11.40

Return on Common Equity 41.24 35.14 34.78 38.13 29.43 33.25 33.45 33.05 32.71 30.14

Return on Capital 27.49 25.45 29.01 31.00 23.29 27.86 27.87 26.06 24.93 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

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E

March 0.28 0.33 0.35 0.39 0.46 0.53 0.60 0.65 0.70 0.71 0.76 0.84

June 0.33 0.46 0.48 0.54 0.61 0.70 0.80 0.94 1.03 1.02 1.09 1.25

September 0.42 0.49 0.52 0.58 0.66 0.78 0.88 0.99 1.06 1.08 1.24 1.34

December 0.39 0.44 0.44 0.52 0.58 0.65 0.72 0.80 0.88 0.90 1.09 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%


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


19

Table 12 Coca-Cola Earnings Per Share

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

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.

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%

Table 13 Comparative EPS 2009

DPS Kraft

General

Mills*

Year 1.97 2.04 3.98

Year to Year 7% 8% 10%

L/T Growth rate 8% 8% 9%

* Fiscal year 2008-2009

PepsiCo Coca-Cola DPS Kraft

General

Mills

Gross Margin 53.51 64.22 59.61 36.15 35.62

Operating Margin 18.61 26.56 19.62 13.53 15.52

Pretax Margin 18.69 28.87 15.69 10.62 13.78

Profit Margin 13.75 22.02 10.03 7.48 8.88

Return on Assets 15.67 15.30 6.37 4.65 7.07

Return on Common Equity 41.24 30.15 19.16 12.54 22.90

Return on Capital 27.49 21.31 11.53 8.95 12.09

Effective Tax Rate 25.99 22.80 36.29 29.37 35.58


20

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

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


Cash Ratio 0.47 0.26 0.32 0.41 0.52 0.51 0.31 0.30 0.33 0.31

Quick Ratio 1.00 0.79 0.89 0.95 0.87 0.95 0.75 0.72 0.76 0.76

Current Ratio 1.44 1.23 1.31 1.33 1.11 1.28 1.08 1.06 1.17 1.17

Total Debt/Total Capital 31% 40% 22% 16% 27% 20% 16% 22% 26% 30%

Cash & Equivalents/Current Assets 33% 21% 24% 31% 47% 40% 29% 29% 28% 27%

Accounts Receivable Turnover-Days 39 39 37 36 36 36 36 34 33 35

Inventory Turnover Days 46 44 43 42 42 40 40 42 42 49

Inventory to Cash Days 85 82 80 78 78 76 77 76 75 84

CFO/Total Debt 86% 85% 147% 215% 113% 146% 189% 168% 127% 138%

Cashflow/Total Liabilities 30% 29% 40% 42% 33% 35% 32% 33% 29% 34%

Working Capital (MM) $3,815 $2,019 $2,398 $2,270 $1,048 $1,887 $515 $361 $855 $822

PepsiCo Coca-Cola

Dr. Pepper

Snapple Kraft

General

Mills

Cash Ratio 0.47 0.67 0.33 0.18 0.21

Quick Ratio 1.00 0.95 0.96 0.64 0.47

Current Ratio 1.44 1.28 1.5 1.08 0.98

Total Debt/Total Capital 31% 32% 48% 42% 57%

Cash & Equivalents/Current Assets 33% 52% 22% 17% 21%

Accounts Receivable Turnover-Days 39 40 35 45 26

Inventory Turnover Days 46 75 43 54 53

Inventory to Cash Days 85 115 78 99 79

CFO/Total Debt 86% 68% 29% 27% 26%

Cashflow/Total Liabilities 30% 35% 15% 12% 15%

Working Capital (MM) $3,815 $3,830 $425 $963 -$71


21

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

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


LT Debt/Common Equity 44.1% 65.1% 24.4% 16.6% 16.3% 17.8% 14.4% 23.1% 30.7% 39.6%

LT Debt/Total Capital 29.2% 38.6% 19.1% 14.0% 11.9% 14.1% 12.0% 17.8% 22.7% 27.8%

LT Debt/Total Assets 18.6% 21.8% 12.1% 8.5% 7.3% 8.6% 6.7% 9.3% 12.2% 14.5%

Total Debt/Common Equity 46.9% 68.2% 27.5% 18.4% 36.6% 25.6% 19.4% 29.0% 34.7% 42.2%

Total Debt/Total Equity 45.1% 68.0% 27.4% 18.4% 36.5% 25.5% 19.3% 28.9% 34.6% 42.1%

Total Debt/Total Capital 31.1% 40.5% 21.5% 15.5% 26.7% 20.3% 16.2% 22.4% 25.7% 29.6%

Total Debt/Total Assets 19.7% 22.9% 13.7% 9.4% 16.4% 12.3% 9.1% 11.7% 13.9% 15.5%

Total Debt/Market Cap 8.2% 9.7% 3.8% 2.8% 5.3% 4.0% 2.9% 3.8% 3.5% 3.7%

PepsiCo Coca-Cola DPS Kraft

General

Mills

LT Debt/Common Equity 44.1% 20.4% 92.9% 69.7% 111.2%

LT Debt/Total Capital 29.2% 13.6% 48.2% 40.1% 46.1%

LT Debt/Total Assets 18.6% 10.4% 33.7% 27.0% 32.2%

Total Debt/Common Equity 46.9% 47.8% 92.9% 73.4% 136.7%

Total Debt/Total Equity 45.1% 46.8% 92.9% 73.1% 130.3%

Total Debt/Total Capital 31.1% 31.9% 48.2% 42.2% 56.6%

Total Debt/Total Assets 19.7% 24.4% 33.7% 28.5% 39.6%

Total Debt/Market Cap 8.2% 9.0% 41.0% 47% 42%


22

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

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

Target Price

P/Forward E 32.5 13.1 20.7 15.1 17.8 4.16 74.05

P/S 3.6 0.9 2.2 2.4 2.2 34.28 75.42

P/B 10.6 3.3 6.7 6.1 6.4 11.51 73.66

P/EBITDA 16.79 5.49 11.91 10.23 11 7.25 79.75

P/CF 24.9 8.1 16.5 13.6 14.5 5.16 74.82Average 75.54

Median 74.82

Target

Multiple

Target

Metric

Value

Valuation Ratio High Low Median Current


P/Trailing E 2 0.88 1.3 0.92

P/Forward E 1.4 0.85 1.2 0.97

P/B 4.3 1.4 2.3 2.6

P/S 2.6 1 1.8 1.8

P/CF 2 1 1.6 1.3

Table 20 PepsiCo Valuation Relative to S&P 500


P/Trailing E 1.2 0.64 0.94 0.98

P/Forward E 1.1 0.64 0.97 0.97

P/B 1.6 0.1 0.7 1.1

P/S 1.3 0.4 0.7 1.1

P/CF 1.3 0.3 1.1 1


23

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

NameTrailing

P/E

Forward

P/E

Price to

Book

Price to

Sales

Price to

Cashflow

Soft Drinks

Coca-Cola Co/The 17.00 15.50 5.00 4.00 14.50

Coca-Cola Enterprises Inc 17.50 16.00 16.00 0.60 7.50

Dr Pepper Snapple Group Inc 17.00 14.10 2.70 1.50 11.70

PepsiCo Inc/NC 17.20 15.10 6.10 2.40 13.60

Soft Drinks Valuation 17.50 15.60 5.40 2.10 13.90

Packaged Foods & Meats

Campbell Soup Co 15.00 14.20 11.90 1.60 11.40

ConAgra Foods Inc 14.30 13.50 2.20 0.90 10.00

Dean Foods Co 10.20 10.60 2.20 0.30 5.40

General Mills Inc 15.00 15.00 3.70 1.60 11.50

Hershey Co/The 19.80 14.50 13.80 2.00 14.90

HJ Heinz Co 16.60 15.60 8.10 1.40 12.50

Hormel Foods Corp 14.60 14.90 2.40 0.80 10.90

JM Smucker Co/The 14.40 15.00 1.40 1.60 10.70

Kellogg Co 17.10 15.10 9.10 1.60 12.90

Kraft Foods Inc 14.80 14.60 1.70 1.30 11.70

McCormick & Co Inc/MD 16.40 15.40 4.00 1.60 12.50

Mead Johnson Nutrition Co 23.70 22.30 NM 3.80 21.00

Sara Lee Corp 14.20 13.10 3.40 0.80 8.40

Tyson Foods Inc 20.70 13.00 1.60 0.30 8.80

Packaged Foods & Meats Valuation 15.80 15.20 2.80 0.90 11.50


24

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.


25

Table 23 PepsiCo Discounted Cash Flow Model

Terminal Discount Rate = 9.5%

Terminal FCF Growth = 4.0%

Year 2009A 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%

Operating Income 8,044 10,549 11,096 11,992 12,447 13,132 13,854 14,547 15,274 15,961 16,600

Operating Margin 18.6% 18.6% 18.1% 17.9% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5%

Interest and Other 35 (578) (625) (684) (854) (900) (950) (997) (1,047) (1,094) (1,138)

Interest % of Sales 0.1% -1.0% -1.0% -1.0% -1.2% -1.2% -1.2% -1.2% -1.2% -1.2% -1.2%

Taxes 2,100 2,792 3,141 3,803 3,990 4,210 4,441 4,663 4,896 5,117 5,321

Tax Rate 26.0% 28.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%

Net Income 5,946 7,179 7,329 7,504 7,573 7,992 8,433 8,856 9,300 9,720 10,110

% Grow th 20.7% 2.1% 2.4% 0.9% 5.5% 5.5% 5.0% 5.0% 4.5% 4.0%

Add Depreciation/Amort 1,635 2,266 2,450 2,684 2,703 2,851 3,008 3,159 3,317 3,466 3,605

% of Sales 3.8% 4.0% 4.0% 4.0% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8%

Plus/(minus) Changes WC (183) 277 33 47 (71) (75) (79) (83) (87) (91) (95)

% of Sales -0.4% 0.5% 0.1% 0.1% -0.1% -0.1% -0.1% -0.1% -0.1% -0.1% -0.1%

Subtract Cap Ex 2,128 3,598 3,369 3,355 3,556 3,602 3,642 3,657 3,666 3,648 3,605

Capex % of sales 4.9% 6.4% 5.5% 5.0% 5.0% 4.8% 4.6% 4.4% 4.2% 4.0% 3.8%

Free Cash Flow 5,270 6,124 6,444 6,880 6,649 7,166 7,720 8,274 8,864 9,446 10,015

% Grow th 16.2% 5.2% 6.8% -3.4% 7.8% 7.7% 7.2% 7.1% 6.6% 6.0%

NPV of Cash Flows 46,750 38%

NPV of terminal value 76,417 62% Terminal Value 189,378

Projected Equity Value 123,167 100%

Free Cash Flow Yield 5.07% Free Cash Yield 5.29%

Current P/E 17.5 14.5 14.2 Terminal P/E 18.7

Projected P/E 20.7 17.2 16.8

Current EV/EBITDA 11.1 8.4 7.9 Terminal EV/EBITDA 9.5

Projected EV/EBITDA 13.1 9.9 9.3

Shares Outstanding 1,653

Current Price 62.89$ Debt 7,400

Implied equity value/share 74.51$ Cash 3,943

Upside/(Downside) to DCF 18.5% Cash/Share 2.39


26

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

pepsico, inc. - max m. fisher college of business · pdf filepepsico, inc. completed its $ 7.8...

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