pepsico, inc. soft drinks

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

15 September 2016Americas/United States

Equity ResearchSoft Drinks

PepsiCo, Inc. (PEP)

INITIATION Rating OUTPERFORMPrice (14-Sep-16,US$) 105.05Target price (US$) 121.0052-week price range 109.96 - 92.37Market cap (US$ m) 151,184Enterprise value (US$ m) 175,781*Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector.¹Target price is for 12 months.

Laurent Grandet212 538 7901

[email protected]

Clay Crumbliss, CFA212 538 1076

[email protected]

Snacks Pep Up Valuation with US Beverages Close Behind; Initiating at OutperformWe are initiating coverage of PepsiCo with an Outperform rating and a $121 target price. Our sales and EPS estimates are generally in-line with the consensus, but we think the market is not giving the company due credit for the marketing and financial strength of the Frito-Lay franchise and the rebalancing of the US Beverages portfolio towards faster growing noncarbonated beverages. ■ Snacks on Steroids Driving the Algorithm and Growth: Frito-Lay is a

best-in-class snacks business that is seemingly immune to competition with white spaces remaining. Mid-single digit sales growth, operating margins breaching 30%, and a staggering 54% U.S. market share merits a premium valuation to food peers and we think Frito-Lay can realize its full value even under the PepsiCo umbrella.

■ Unrivaled U.S. Beverage Brand Line-up: By focusing less on colas and having a broader view of the nonalcoholic beverages category, PepsiCo has gained leadership positions in some of the fastest growing categories. This strategy is delivering growth that more than offsets ~2% declines of its carbonated portfolio. In addition, the company keeps filling the innovation pipeline by exploring new territories and refreshing the current line-up.

■ International Beverages is the Weak Spot: Low market share, lack of scale and investment, and executional challenges leave room for improvement. However, we see no easy internal fix and think it would require substantial investment over a long period of time that is better used to further reinforce the US beverage business, in our view.

■ Valuation: Our target price assumes a 22x P/E on our discounted CY18 estimate, which is a slight premium to U.S. Staples. We maintain a discount to KO owing to Coke's asset-light, lower risk model. Our SOTP analysis supports our overall valuation, dominated by a global food enterprise value of $138B representing the majority of our total PepsiCo EV.

Quarterly EPS Q1 Q2 Q3 Q42015A 0.83 1.32 1.35 1.062016E 0.89 1.35 1.29 1.222017E 1.00 1.48 1.44 1.28

Financial and valuation metricsYear 12/15A 12/16E 12/17E 12/18EEPS (CS adj.) (US$) 4.57 4.75 5.19 5.62Prev. EPS (US$) - - - -P/E (x) 23.0 22.1 20.2 18.7Revenue (US$ m) 63,056.0 62,382.3 63,373.0 65,450.0EBITDA (US$ m) 12,353 12,694 13,448 14,190EV/EBITDA (current) 14.3 14.0 13.2 12.5FCF yield (%) 5.0 4.7 5.1 5.4Net debt (US$ m) 24,188 24,597 23,887 23,131ROIC (%) 21 21 22 23

Number of shares (m) 1,439 IC (current, US$ m) 36,218EV/IC (x) 4.6 Net debt (Next Qtr., US$ m) 26,424.8Dividend (current, US$) 2.96 Net debt/EBITDA (12/15A) 2.1Dividend yield (%) 2.87BV/share (Next Qtr., US$) 8.5Source: Company data, Thomson Reuters, Credit Suisse estimates

15 September 2016

PepsiCo, Inc. (PEP) 2

PepsiCo, Inc. (PEP)Price (14 Sep 2016): US$105.05; Rating: OUTPERFORM; Target Price: US$121.00; Analyst: Laurent GrandetIncome Statement 12/15A 12/16E 12/17E 12/18ERevenue (US$ m) 63,056.0 62,382.3 63,373.0 65,450.0EBITDA 12,353 12,694 13,448 14,190Depr. & amort. (2,416) (2,527) (2,578) (2,668)EBIT (US$) 9,937 10,167 10,870 11,523Net interest exp (911) (957) (965) (961)Associates - - - -Other adj. 0 0 0 0PBT (US$) 9,026 9,210 9,905 10,561Income taxes (2,189) (2,256) (2,427) (2,588)Profit after tax 6,837 6,953 7,478 7,974Minorities (49) (55) (60) (60)Preferred dividends - - - -Associates & other 0 0 0 0Net profit (US$) 6,788 6,898 7,418 7,914Other NPAT adjustments (1,336) 0 0 0Reported net income 5,452 6,898 7,418 7,914Cash Flow 12/15A 12/16E 12/17E 12/18EEBIT 9,937 10,167 10,870 11,523Net interest (911) (957) (965) (961)Cash taxes paid - - - -Change in working capital 987 6 345 312Other cash & non-cash items 567 796 191 120Cash flow from operations 10,580 10,011 10,441 10,994CAPEX (2,758) (2,807) (2,852) (2,945)Free cashflow to the firm 7,822 7,204 7,589 8,049Aquisitions - (71) 0 0Divestments 96 47 0 0Other investment/(outflows) (907) (665) 0 0Cash flow from investments (3,569) (3,496) (2,852) (2,945)Net share issue(/repurchase) 0 0 0 0Dividends paid (4,040) (4,234) (4,525) (4,774)Issuance (retirement) of debt 4,607 2,268 0 66Other (9,003) (4,958) (2,354) (2,584)Cashflow from financing activities (8,436) (6,924) (6,879) (7,293)Effect of exchange rates - - - -Changes in Net Cash/Debt (1,425) (409) 710 756Net debt at start 22,763 24,188 24,597 23,887Change in net debt 1,425 409 (710) (756)Net debt at end 24,188 24,597 23,887 23,131Balance Sheet (US$) 12/15A 12/16E 12/17E 12/18EAssetsCash & cash equivalents 9,096 11,024 11,734 12,556Account receivables 6,437 6,294 6,639 6,070Inventory 2,720 3,023 2,947 3,126Other current assets 4,778 4,367 4,436 4,582Total current assets 23,031 24,708 25,757 26,333Total fixed assets 16,317 16,670 17,023 17,382Intangible assets and goodwill 27,258 27,699 27,620 27,539Investment securities - - - -Other assets 3,061 2,869 2,869 2,869Total assets 69,667 71,946 73,269 74,123LiabilitiesAccounts payables 13,507 13,019 13,704 13,771Short-term debt 4,071 4,774 4,774 4,774Other short term liabilities 0 0 (0) 0Total current liabilities 17,578 17,793 18,478 18,545Long-term debt 29,213 30,847 30,847 30,913Other liabilities 10,846 10,949 10,749 10,549Total liabilities 57,637 59,589 60,074 60,006Shareholder equity 12,068 12,376 13,215 14,136Minority interests (38) (19) (19) (19)Total liabilities and equity 69,667 71,946 73,269 74,123Net debt 24,188 24,597 23,887 23,131

Per share 12/15A 12/16E 12/17E 12/18ENo. of shares (wtd avg) 1,487 1,451 1,429 1,409CS adj. EPS 4.57 4.75 5.19 5.62Prev. EPS (US$)Dividend (US$) 2.76 2.96 3.17 3.39Dividend payout ratio 60.51 62.26 61.00 60.33Free cash flow per share 5.26 4.96 5.31 5.71Earnings 12/15A 12/16E 12/17E 12/18ESales growth (%) (5.4) (1.1) 1.6 3.3EBIT growth (%) (3.6) 2.3 6.9 6.0Net profit growth (%) (3.9) 1.6 7.5 6.7EPS growth (%) (1.3) 4.1 9.2 8.2EBITDA margin (%) 19.6 20.3 21.2 21.7EBIT margin (%) 15.8 16.3 17.2 17.6Pretax margin (%) 14.3 14.8 15.6 16.1Net margin (%) 10.8 11.1 11.7 12.1Valuation 12/15A 12/16E 12/17E 12/18EEV/Sales (x) 2.78 2.82 2.76 2.66EV/EBITDA (x) 14.3 14.0 13.2 12.5EV/EBIT (x) 17.6 17.3 16.1 15.1P/E (x) 23.0 22.1 20.2 18.7Price to book (x) 12.9 12.3 11.4 10.5Asset turnover 0.9 0.9 0.9 0.9Returns 12/15A 12/16E 12/17E 12/18EROE stated-return on (%) 36.8 56.4 58.0 57.9ROIC (%) 0.2 0.2 0.2 0.2Interest burden (%) 0.91 0.91 0.91 0.92Tax rate (%) 24.3 24.5 24.5 24.5Financial leverage (%) 2.76 2.88 2.70 2.52Gearing 12/15A 12/16E 12/17E 12/18ENet debt/equity (%) 201.1 199.1 181.0 163.9Net Debt to EBITDA (x) 2.0 1.9 1.8 1.6Interest coverage ratio (X) 10.9 10.6 11.3 12.0Quarterly EPS Q1 Q2 Q3 Q42015A 0.83 1.32 1.35 1.062016E 0.89 1.35 1.29 1.222017E 1.00 1.48 1.44 1.28

Share price performance

PEP.N S& P 5 0 0 IN D EX

O ct - 1 5 Jan - 1 6 A p r - 1 6 Ju l - 1 68 59 09 5

1 0 01 0 51 1 0

On 14-Sep-2016 the S&P 500 INDEX closed at 2125.77Daily Sep16, 2015 - Sep14, 2016, 09/16/15 = US$93.07

Source: Company data, Thomson Reuters, Credit Suisse estimates

15 September 2016


Key ChartsFigure 1: PepsiCo SWOT

Strengths Weaknesses

•

•

•

FritoLay undisputable market leadership and best-in-class returnsA US beverage brand line up like none other with leadership position in growing non-carb segmentsInnovation as % of net revenue higher than competition in the US

•

••

Scale and investment deficit vs primary beverage competitor internationallyPredominately US business and managementContinuous market decline of flagship beverage brand globally

Opportunities Threats

•

••

Filling snack white spaces internationally and increase per capita consumptionLeverage successes to increase on-premise shareStrengthen bottling strategic approach outside the US

•

••

Impact of sugar tax and further medical research supporting the link between excess sugar consumption, diabetes and obesity Increased competition from Coke and local players Risk of Pepsi losing relevance in some markets

Source: Credit Suisse.

Figure 2: PepsiCo Is as Much a Food Company as It Is a Beverage Company

Figure 3: Frito-Lay Boasts Superior Operating Margins Compared with Peers

Food53%

Bev47%

Global Revenue Split

29%

21%

11%

5%

15%

25%

35%

FLNA Mondelez N.A. Kellogg N.A.Snacks

Ope

ratin

g M

argi

n (%

)

Snacks Operating Margin Benchmark

Source: Company data, Credit Suisse. Source: Company data, Credit Suisse.

Figure 4: The NCB Portfolio Is Making Up for the Underperformance of CSD in the United States

Figure 5: 64% of PepsiCo's EV Is Driven by the Global Food Business

18.0

18.5

19.0

19.5

20.0

2012 CSD NCB 2015

Ret

ail S

ales

($B

)

Beverage Sales Contribution Bridge

$19.0

$19.6

($0.6)

$1.2

$61

$18

$138

$61

$161

$0

$50

$100

$150

$200

N.A. Bev Int'l Bev Food

Ent

erpr

ise

Val

ue ($

BB

)

Relative Parts Valuation

Pepsi Coke

Source: Nielsen xAOC+C, Credit Suisse. Source: Credit Suisse.

15 September 2016


Initiating at Outperform; $121We are initiating coverage of PepsiCo Inc., or "PepsiCo" (PEP), with an Outperform rating. Our $121 target price implies 15% upside to the shares. Our valuation assumes a 22x P/E on our discounted CY18 EPS estimate, a slight premium to U.S. staples peers and a discount to Coca-Cola. We think this is fair relative to KO because of Coke's new asset-light, lower-risk model. The real difference for PepsiCo is the value of the global food business, primarily Frito-Lay. For context, our overall valuation multiple represents a slight premium to the level at which Mondelez currently trades.

Figure 6: We Value PEP at a 22x P/E, a Discount to KO and a Premium to DPS

22.0x

14.6x

23.0x

17.8x

21.0x

12.9x

5x

10x

15x

20x

25x

30x

PE EV / EBITDA

Val

uatio

n M

ultip

le (x

)

Credit Suisse Valuation Framework - US NAB

PEP KO DPS

Source: Credit Suisse estimates.The multiples shown reflect where the US Beverages Equity Research team values each stock (not necessarily where each is trading).

Our EstimatesWe are introducing our 2016-18 EPS estimates of $4.75, $5.19, and $5.62, respectively. This implies 7% annual EPS growth over the three-year period, which we think is achievable given the momentum of the Frito-Lay business globally and the strength of the U.S. nonalcoholic beverage (NAB) portfolio. Our estimates are broadly in-line with the consensus.

Upside/Downside Scenarios:■ Blue Sky: We see additional upside if the growth gap between CSD and NCBs

increased in favor of NCBs, moving the algorithm further in PepsiCo's favor; this would merit a higher multiple

■ Grey Sky: Earnings would be negatively impacted if NCB growth were to stall (vs our expectation of ~5% growth); this would cause the stock to merit a lower multiple

15 September 2016


Figure 7: Our Downside and Upside Scenarios Range from $106 to $136 per Share, Respectively

Scenarios CS FY18E Value

($ per share) EPS ($) PE (x) Eq V ($) 1 Comments

Bull Case $6.18 22.5x $136 NCB/CSD growth trajectories diverge more than base case; higher multiple

Base Case $5.62 22.0x $121 Base case valuation

Bear Case $5.06 21.5x $106 NCB grows stalls; lower multiple

1. Discounted back 0.3 years from FY18 to represent the expected stock price using a NTM multiple, one-year from today

Source: Credit Suisse estimates.Note: Uses discounted calendar year earnings estimates that may not match estimates shown elsewhere in the document.

15 September 2016


Investment Thesis■ Frito-Lay U.S., the PepsiCo North Star

■ U.S. Beverages on the Right Track by Broadening the Scope

■ International Beverages Not Benefiting Fully from Category Growth

■ Algorithm and Valuation Driven by Food and Improvement of U.S. Beverages

Frito-Lay US, the PepsiCo North StarWe think investors may be underestimating the importance of food to the overall PepsiCo portfolio. On a global basis, food makes up around 54% of sales. The relative size of the food business is certainly no secret, but we think its true significance is less appreciated.

Figure 8: Food Represents 46% of the North American Business…

Figure 9: … and 64% of the International Business

Food46%

Bev54%

US Revenue Split

Food64%

Bev36%

International Revenue Split

Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.

With our estimation of the international food business, we estimate the total food operating margin represents around 64% of the company’s profitability.

U.S. Food Outperforming North American Food PeersIn 2015, Frito-Lay NA represented only 23% of PepsiCo global sales but almost 40% of its profit. To put this into perspective, Frito-Lay NA is a $15B business, which is more than twice the size of Mondelez North America. Quaker Foods NA generates $2.5B in sales, just less than Kellogg NA Morning Foods at $3B.

In terms of operating margin, Frito-Lay North America's (FLNA) results are best in class and no other food company that size in the United States competes at its level. Over the past few years, operating margins have gradually improved 40-100bps per year and even breached the 30% threshold in the 2Q of this year, reaching 30.5%. This translates to an estimated $4.6B of profits for FY 2016.

15 September 2016


Figure 10: Frito-Lay North America Is the Second Largest PepsiCo Segment and Has the Highest Operating Margin and Profit Contribution

23%

4%

33%

13%17%

10%

39%

5%

25%

11% 11% 9%

FLNA QFNA NAB LA ESSA AMENA

Rel

ativ

e S

ize

of S

egm

ent

Segment Contribution

Sales Profit

29% 22% 13% 14% 11% 16%

Ope

ratin

gM

argi

n

Source: Company data, Credit Suisse estimates.Note: Segment financials as of FY15

Figure 11: Frito-Lay Has Much Better Margins Compared with Snack Peers…

Figure 12: … as Quaker to Its Primary Breakfast Peer

29%

21%

11%

5%

10%

15%

20%

25%

30%

35%

FLNA Mondelez N.A. Kellogg N.A.Snacks

Ope

ratin

g M

argi

n (%

)

Snacks Operating Margin Benchmark

22%

18%

5%

10%

15%

20%

25%

30%

35%

Quaker Kellogg N.A. MorningFoods

Ope

ratin

g M

argi

n (%

)

Breakfast Operating Margin Benchmark

Source: Company data, Credit Suisse estimates.Note: Mondelez margin represents the Credit Suisse Food Research FY16 projected margin, which is higher than today's actual results

Source: Company data, Credit Suisse estimates.

For comparison also, the leading European food companies such as Nestle or Danone are just slightly above 15% operating margins.

Frito-Lay Has a Commanding U.S. Retail Market Share That Is GrowingFor years, FLNA has been delivering volume growth and was able to increase price/mix consistently. Retail sales growth has been oscillating between 2% and 5% more recently, and we don't see any reason for this to change in the foreseeable future for the following

15 September 2016


major reasons: (1) the continuous category growth, (2) the absence of a strong competitor in the U.S. salty snacks business and (3) the power of its brands.

With growing urbanization and more and more people on the Go, the snacking occasion keeps growing and is evaluated to be a $100B category just in the United States. This provides Frito-Lay $15B business a lot of opportunities to go after.

Owing to its direct store delivery system (DSD), Frito-Lay excels in in-store execution (shelf management, replenishment, and promotion) and is not challenged by any competitor. Pringles, the largest non-Frito brand, with 3.1% share of the U.S. market, isn't benefiting (yet) from Kellogg's DSD and enables Frito-Lay to essentially own the shelves. Total market shares keeps growing and reached a commanding 56% in the latest Nielsen data, with a 50% share in the largest potato chips category and even 62% in tortilla chips.

Figure 13: Frito-Lay Is Growing at a Healthy Low-Single-Digit Pace in the United States

(2%)

(1%)

0%

1%

2%

3%

4%

5%

6%

4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16

Ret

ail S

ales

Gro

wth

(%)

Frito-Lay Retail Sales Growth

Total Sales Volume Pricing

Source: Nielsen xAOC+C, Credit Suisse.

Figure 14: FL Owns More than 50% of the Potato Chip Category

Figure 15: FL Owns More than 62% of the Tortilla Chip Category

Lays38%

Ruffles12%

Pringles11%

All other brands31%

PL8%

Potato Chip Retail Share

Doritos42%

Tostitos20%

Santitas5%

All other brands27%

PL6%

Tortilla Chip Retail Share

Source: Source: Nielsen xAOC+C, Credit Suisse.Note: LTM as of 30 July 2016.

Source: Source: Nielsen xAOC+C, Credit Suisse.Note: LTM as of 30 July 2016.

15 September 2016


Brands Are What Define Frito-LayOf the top six salty snacks brands, five belong to Frito-Lay. Two of those brands, Lay's and Doritos, represent respectively $2.8B and $2B in revenue. To give an additional perspective, Oreo, the leading cookie from Mondelez, topped $1.4B in 2015 in the United States. Each brand has its own brand identity and territory like flavors for Lays and boldness for Doritos which makes overlaps minimal.

Figure 16: Frito-Lay Owns the Salty Snacks Category in the United States with Four of the Top Five Brands (Seven of the Top Ten)

Rank 1 Owner Share Size ($B)

1 Frito-Lay 10.5% $2.8

2 Frito-Lay 7.8% $2.0

3 Frito-Lay 5.8% $1.5

4 Frito-Lay 3.3% $0.9

5 Kellogg 3.1% $0.8

6 Frito-Lay 1.8% $0.5

Source: Nielsen xAOC+C, Credit Suisse.Note: LTM as of 02 July 2016.1. This chart only depicts branded share. Private label has the second largest dollar sales in salty snacks at $2.2B.

Beyond its flagship billion dollar brands, Frito-Lay also generates sales from every segment and niche of the snacks category, with more than twenty other brands such as Stacy's pita chips, Cracker Jack, Miss Vickie's, and Sun Chips. Frito-Lay is covering every corner of the salty snacks category and has now entered the nuts business with Nut Harvest and Munchies.

One area in which Frito-Lay has differed from many of its food peers with leading positions has been its ability to innovate as successfully as its challengers. According to our analysis, Frito-Lay has actually gotten its fair share of the innovation over the past five years, at around 50-55%, with only one new serious competitor emerging (PopChips). Frito-Lay seems to be immune to competition, or at least able to manage it very well.

Finally, innovation doesn’t stop in retail. Frito-Lay has been leveraging the power of its brands and its flavoring expertise to enter the culinary space. Since Taco Bell launched a taco made out of Doritos tortilla chips in 2014, more than a billion Doritos Locos Tacos have been sold.

15 September 2016


Frito-Lay International Following on the Same Path Food to our estimation represents 64% of PepsiCo's international business ($16B) with some sizeable local strongholds such as the Sabritas salty snacks and Gamesa biscuits business in Mexico or Walkers in the United Kingdom.

A key difference to the beverage business that is mostly franchise outside the United States, Frito-Lay business is company-owned and developed gradually by entering from scratch in a new territory such as Germany or Italy recently or as a result of an acquisition of a strong, local potato chips player. What is interesting and specific about those investments is that Frito-Lay decided not to migrate necessarily the local brand into Lay's franchise. In the current environment, with Millennials turning their back to global brands and where local relevancy is an asset, this strategy should play in Frito-Lay's favor.

On the back of an ever-growing urbanization and demand for convenient food, snacking occasions are growing internationally. Frito-Lay is benefiting from it and, as in the United States, doesn't have a global competitor to deal with, just strong local brands such as Bimbo in Mexico and KP foods in Europe, to name a few.

To further build local relevancy, Frito-Lay has developed and launched successfully specific local flavors as illustrated in Figure 17 and Figure 18.

Figure 17: Lay's Quality Inside the Bag with the Local Brands on the Outside (Examples from the United Kingdom, Mexico, and Australia)

Source: Company website.

Figure 18: Local Flavoring to Appeal to Local Preference


15 September 2016


U.S. Beverages on the Right Track by Broadening the Scope PepsiCo's North America Beverages business has been improving over the past three years in comparison with other company segments, but it is still underperforming Coke North America.

In the long term, we are positive because we think the algorithm is moving in PepsiCo's favor. This is primarily owing to a broader and stronger portfolio of noncarbonated beverages brands that is growing faster than the company's competitor despite losing shares in a declining CSD category.

In our model, we assume there will be no material change to the on-premise channel, as any large swing from Coke to PepsiCo or visa-versa is a rare occurrence. In addition, if such a change were to happen, we consider the financial incentive will be such that the gained volume would not materially add significant profit margin before the end of 2018.

Figure 19: PepsiCo NCB Portfolio Is Driving the Growth of the North America Beverage Segment and More Than Offsetting CSD Declines

18.0

18.5

19.0

19.5

20.0

2012 CSD NCB 2015

Ret

ail S

ales

($B

)

Retail Beverage Sales Contribution Bridge from 2012 to 2015

$19.0

$19.6

($0.6)

$1.2

Source: Nielsen xAOC+C, Credit Suisse.Note: Recognizes 50% of the sales and accompanying growth from the Lipton and Starbucks joint ventures in tea and coffee

15 September 2016


Figure 20: CSDs Continue to Lose Volume at Around 2% per Year When NCBs Are Gaining 3-4%

(3%)(2%)

(2%) (2%)

2% 3%

5%

4%

(4%)

(3%)

(2%)

(1%)

0%

1%

2%

3%

4%

5%

2013 2014 2015 LTM

Ret

ail V

olum

e G

row

th (%

)

US NAB Category Retail Volume Growth

CSD Volume NCB Volume

Source: Nielsen xAOC+C, Credit Suisse.Note: LTM as of 13 August 2016

CSD Category Declines Continue… and to an Even Greater Extent for PepsiCoCategory Volume: Since it peaked in 2004, the U.S. CSD category has been in constant decline. We have identified a few reasons for that:

■ Wider awareness of, and growing concern about, obesity/calories/sugar compounded by the negative press from continued state sugar tax legislation

■ Increased competition on both ends of the spectrum from other healthier categories and from caffeine-charged but aspirational energy drinks

■ Millennials resistance to big brands and traditional marketing

We don't see the trend changing in the medium term because:

■ New tax laws are showing up across the country imposing a much higher levy; the latest one in Philadelphia could be the new precedent. Besides the higher impact on sales (that will need to be assessed), this just reinforces the negative messages singling out the CSD category and colas specifically

■ No-calorie CSD options are currently declining faster than full-calorie, as artificiality has become the new evil for consumers and midcalorie naturally sweetened with Stevia offerings are not getting traction owing to a disappointing taste profile

■ Bottled water will continue to grow at high-single-digit rate from a larger base, becoming for the first time ever this year a larger volume category than colas, and on the other end of the spectrum, energy drinks will continue to grow at a solid pace, seemingly immune from the issues that have plagued the major CSD brands. Finally, more entrepreneurial, crafty beverage options are flourishing every day

All in all, we project that the U.S. CSD volumes will continue to decline around 2% per year, similar to the rate seen over the past three years.

15 September 2016


Share: Over the past three years, PepsiCo has lost to its competitor (later we will see the reverse is true on NCBs) on average 1% point to 2% points annually. We project a similar share decline going forward, as KO will continue to overspend in the category versus PepsiCo.

Figure 21: PepsiCo's CSD Share Gap with Coke Has Expanded by More than 500 BPS Since 2012

Figure 22: PepsiCo CSD Volumes Are Declining Faster than Coke and the Category

30%

40%

50%

60%

70%

2012 2013 2014 2015 LTM

Ret

ail V

alue

Sha

re(%

)

CSD Retail Value Share vs Coke

PepsiCo Coke

+550 bps(3%) (3%)

(10%)

(1%)(1%) (0%)

(5%)

3%

(12%)

(10%)

(8%)

(6%)

(4%)

(2%)

0%

2%

4%

Total Regular Cola Diet Cola Flavors

Ret

ail V

olum

e G

row

th (%

)

CSD Retail Volume Declines since 2012

Pepsi Coke

Source: Nielsen xAOC+C, Credit Suisse.Note: LTM as of 13 August 2016

Source: Nielsen xAOC+C, Credit Suisse.

Price/Mix has generally been used as a way to mitigate the impact of volume declines in the past. We can split price/mix into the following components: (1) the price increase at the SKU level, (2) the percent and depth of the promotional activity, and (3) the pack mix of the portfolio.

Managing the mix through an astute pack/price strategy has been the largest opportunity for the beverage companies. This is even truer today that consumers are asking for smaller serving sizes to reduce calorie intake and willing to pay a premium for it. In the supermarket channel over the past 12 months, data suggest that volumes of 7.5-8.0oz cans (eight-packs) have increased by 6%. At the same time, 12oz cans (12 pack) decreased by 4%. The smaller cans sell at a 47% premium on an equivalent basis, a price consumers are willing to pay for fewer calories.

Our model for CSDs assumes the following:

■ Price: We are projecting an around 1% price increase per year to compensate for inflation.

■ Promotional Activity: We are not planning for any change. Our data show that PepsiCo's CSD promotional activity has been relatively constant (~50% on deal at any given time with some seasonal fluctuations) since 2011.

■ Mix: Here we plan 1-2% annually for the mix benefit of price-pack changes: 1% in year one to 2% in year three. As the base of smaller, more accretive SKU such as the 8oz can or 500ml PET increase, the price mix increases more favorably as years pass.

By our math, we expect net price/mix to increase from 2% in Year one to 3% in year three.

In total, our assumptions equate to CSD sales growth in the range of -2% to 0%, with the primary variable being share performance.

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Figure 23: We Estimate PepsiCo's CSD Business Will Decline on Average Around 2% per Year over the Coming Three Years($ in billions) Yr 0 Yr 1 Yr 2 Yr 3

CSD (category) 36,300 35,574 34,863 34,165Category growth (2%) (2%) (2%)PepsiCo share 26% 25% 25% 25%

PepsiCoVolume (4%) (4%) (4%)Price 1% 1% 1%Mix 1% 2% 2%

Sales Growth (2%) (1%) (0%)

Source: Credit Suisse estimates.Note: CSD includes energy

Leading NCB Portfolio Is Driving Growth and Becoming a Larger Share of the N.A. Beverage BusinessThe focus PepsiCo is bringing to the NCB category is paying off on the sales line. PepsiCo holds a strong leadership position in NCB, with leading brands in the top five NCB categories.

This will lead to a larger NCB portfolio as a share of total PepsiCo beverages. PepsiCo's NCB brands are fast growing and hold leading shares in their respective beverage categories. As we show in Figure 24, the company has the number one share in sports drinks, tea, coffee, and juice. This is an impressive lineup of brands that we consider second to none in the beverage space.

Figure 24: PepsiCo Holds the Number One Spot in Four Major NCB Categories

Category Sports 1 Tea 2 Coffee 4 Juice 6 Water

Size $6.3 $4.9 $2.4 $6.7 $12.2Growth 6% 7% 15% 0% 9%

PepsiCo Rank #1 #1 #1 #1 7 #3 8

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Brand Share 77% 30% 75% 29% 8%Brand Growth 5% 11% 15% 2% 8%

Source: Nielsen xAOC+C, Credit Suisse.1. Category represents isotonic beverages as defined by Nielsen2. Category represents liquid tea, refrigerated liquid tea, and new age beverage tea as defined by Nielsen3. Partnership with Unilever; includes Lipton, Brisk, and Pure Leaf brands4. Category represents RTD liquid coffee category as defined by Nielsen5. Partnership with Starbucks6. Category represents refrigerated juices as defined by Nielsen7. Our ranking considers Tropicana and Naked within the category; Coca-Cola is a close number 2 with Simply and Minute Maid8. Excludes private label which leads the category in aggregate

Sports Drinks: Gatorade is the undisputable leader with 77% of market share.

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It should be noted that, in this segment, a new player, Body Armor, is starting to gain traction with its claim of a more natural source of electrolytes. Body Armor is partly owned by Dr Pepper Snapple and is primarily targeting the number two brand, Powerade (KO).

We don't think this will have a large impact on Gatorade's share in the United States over the coming years. Ever since Gatorade reasserted its sports credentials, the brand has rebounded and been growing consistently at a 5% CAGR. PepsiCo is now expanding the Gatorade franchise into protein drinks and bars, which can only reinforce the brand's long-term positioning and add new revenue streams. Very recently, Gatorade also announced it is introducing the first organic (USDA-Certified) Gatorade at a $0.50 premium ($1.69) to the Gatorade core line.

Tea: PepsiCo is leading one of the fastest growing and largest NCB categories by taking a segmented approach with four distinct brands: Brisk, Lipton (now also available sparkling), Pure Leaf, and Tazo. Unlike sports drinks and coffee, tea is a very competitive category with multiple strong brands in the space, and we believe competition can only grow for PepsiCo.

Now that AriZona is getting its act together after two troubling years, we can likely expect Brisk to suffer more. On the more premium front, Honest Tea is, after having been bought and then incubated by VEB (Venture Emerging Brands, Coke's venture arm), now at the center of the Coke strategy and should also receive more investment and attention from the Coke bottling system. However, there is still a long way to go, as in 2015, Honest Tea generated retail sales of ~$110M, according to Nielsen. In addition to its established competitors, PepsiCo is now facing competition from multiple local entrepreneurial brands that are exploiting the diversity of health credentials and variety that teas can provide (e.g., Matcha, red rooibos teas). We believe everyone in the space is also anxious to understand how the ABI/Starbucks partnership with Teavana will play out.

Tea is nearly a $5B category and one in which market share will be the most difficult to defend in our view. Authenticity will be key, and the ability to exploit the Lipton-Unilever tea heritage could be a strong asset. We factored a 3%-pt loss of market share by the end of 2018 in our model.

Coffee: There is no real large competitor to the $2.4B Starbucks-PepsiCo JV business. Despite commending a 75% share, the brand is still growing by 15%, in-line with the category. Starbucks leadership in every niche segment is a strong barrier to entry to competitors, evidenced by the recent introduction into cold brew coffee. Starbucks is defining the space here and can benefit from the network of more than 12,500 Starbucks stores when launching a new concept.

This should restrain any competitor to gain much traction, and therefore we forecast PepsiCo/Starbucks to continue to enjoy a 75% market share and 10-15% growth by 2018.

Juice: Relatively speaking, this is the less profitable business of all NCBs. Competition is fierce, especially in the lower- and middle-priced segments with private label or local brands taking shares. PepsiCo seems to be torn with Tropicana between volume (Twister, ambient juice) and getting more premium and aspirational (Farmland line). It's not clear if the company has found the right balance there, but it is certainly having success with the Naked brand ultra-premium juice. Naked has been growing steadily over the past five years (11% CAGR) and should breach $700M retail sales this year in the United States. In addition, it is still testing and expanding into an even more premium price-point with Naked Chia and Naked Pressed, which sit in the popular premium cold-pressed juices.

We should continue to see growth coming from Naked with stable Tropicana at best and therefore marginally see margin improvement from a very low base.

Water: This is by far the largest segment ($12B) and growing still at an enviable 8-10% per year. This year, for the first time in U.S. history, we should even see volumes of bottled

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water sold surpassing the volume of cola. That's not a small thing. The issue with water is profitability, but it's a space you can't avoid because of its size, its growth, and requests from customers.

For our financials benchmarking, we used the U.S. best-in-class, Nestle's water. Its U.S. division is the leading water player with a two-tier brand strategy: Pure Life (processed water competing directly with PepsiCo's Aquafina and Dasani's Coke) and a range of local spring waters, the largest one being Poland Spring. Nestle's water division recorded an EBIT margin of 11.5% before central costs c150 bps. While the United States is probably accretive to the global water business for Nestle, we can assume Pure Life being at the high-single-digit level as Aquafina or Dasani should be.

We don't forecast much change in the Aquafina business even as it goes into sparkling and flavored sparkling. We think a major move would be to go after a premium value-added water brand such as Ultra Alkaline Brands to compete against Coke's successful Smartwater.

All share and growth references in this section are calculated according to Nielsen xAOC+C

So Net, What Does It Mean for PepsiCo NCBs Portfolio?Our growth projections start with category volumes around 4%. We think this is sustainable over the coming three years, driven by many of the same trends that are causing CSD volume declines. In addition, we assume around 1pt of pricing to compensate for inflation. We remain conservative in terms of the PepsiCo market, holding it flat with the nuances per sub segment as indicated. We think there is upside potential to this because we expect about 30% of sales coming from products that didn't exist three years ago. This is a target PepsiCo management told us it was pursuing, and those innovations are usually less discounted or sold at a premium.

Figure 25: We Estimate PepsiCo's NCB Business Will Increase on Average Around 4-6% per Year over the Coming Three Years($ in billions) Yr 0 Yr 1 Yr 2 Yr 3

NCB (category) 58,000 60,320 62,733 65,242Category growth 4% 4% 4%PepsiCo share 18% 18% 18% 18%

PepsiCoVolume 4% 4% 4%Price 1% 1% 1%Mix 0% 0% 0%

Sales Growth 5% 5% 5%

Source: Credit Suisse estimates.

It's important to note that our sales analysis includes PepsiCo's share (we assume 50%) of sales from the tea and coffee partnerships, which the company does not actually report in its consolidated net sales. Therefore, there is a slight disconnect between this analysis and our model. Reconciling it to our published sales projections, we assume that tea and coffee are growing 10-15% per year and make up less than 20% of the NCB portfolio, so the remaining 80% is growing around 3-4% compared with the 5-6% we show here.

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PepsiCo Beverages U.S. Is Driving an Aggressive Innovation Agenda with Already Some Clear Successes As mentioned, PepsiCo targets to have 30% of its revenue coming from products that didn't exist three years prior. That's a very ambitious goal and is quite different from what was the industry norm just ten years ago.

As we illustrate in Figure 26 and Figure 27, innovations are touching all categories and have an overarching objective to revitalize declining segments, such as in colas, or expand into new adjacent categories, such as protein, cold press juices, or cold brew coffee.

Figure 26: PepsiCo's Innovation in the CSD Space


Figure 27: PepsiCo's Innovation in the NCB Space


One category that PepsiCo failed to uncover and develop, just as its main competitor, is the energy category.

Energy is one of the fastest NAB category in the United States, with sales outgrowing total NAB by an average of 4% points and CSD by 8% points. The company's primary energy brands (Rockstar [distribution agreement] and AMP) together have around 9.3% value share of the energy drink market, with AMP in steep decline recently (down ~30%+ in the latest period according to Nielsen). The problem for PepsiCo is that Monster and Red Bull essentially own the market. Coke fixed its energy problem when it took a 17% stake in Monster and traded all its energy brands for Monster's nonenergy brands. Coke now has direct exposure to the expected outsized growth of the energy category over the coming years. We think the tie-up between Coke and Monster is a huge risk for PepsiCo, as it could essentially block the company from ever having a meaningful presence in the category.

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Figure 28: Energy Sales Growth Consistently Outpacing the Overall NAB Category

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Source: Nielsen xAOC+C, Credit Suisse.LTM as of 13 August 2016

However, PepsiCo may have found the magic bullet with Mtn Dew Kickstart by leveraging its strongest CSD franchise to enter the energy category. According to the latest Nielsen data, Mtn Dew Kickstart is already a ~$350M retail brand and delivering solid ~20% growth, even accelerating in the latest August period (+24%) thanks to new flavors. Kickstart already represents about 9% of the Monster U.S. business.

These results didn't go unnoticed at Monster. Rodney Saks, Monster's CEO, acknowledged at the June 14 annual shareholder meeting that Mtn Dew has taken aim at the energy category with Kickstart, stating "they're obviously targeting us, attacking us on our flank." As a response, Monster is now launching Mutant (what Monster considers an energized CSD) in U.S. convenience stores to go after Mtn Dew.

We think the coming few periods will be interesting to track as we wait to see whether Kickstart will derail Monster growth or if Mutant will erode Mtn Dew share. All the while, Coke will be closely watching from the sidelines.

For the sake of our exercise, we included Kickstart volume growth in PepsiCo's CSD algorithm. Even though it's targeting the energy space, the price per 8oz is closer to that of CSD, and the brand is a CSD derivative. We assumed the profitability is closer to that of CSD, too.

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Figure 29: Mtn Dew Kickstart Offers a Potential In-House Fix for the Energy Category


NCBs Are Less Profitable than CSDs, but the Algorithm Still WorksWe estimate that NCBs made up around 42% and 45% of North America Beverage sales and profits in 2015, respectively. Given our growth and margin assumptions, we think NCB sales and profits will each expand by 5-6 pts as a percent of the total over the coming five years.

Figure 30: The NCB Sales and Profit Base Will Grow Larger as a Portion of the Whole as Time Goes on Owing to the Faster Overall Growth Profile

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The profit story will not be quite as positive as the top line for a couple of reasons:

■ Water and juice are margin dilutive but dollar profit accretive, although far less so than CSD.

■ Coffee and tea profits needs to be split (we assume 50/50) among PepsiCo and its partners, Unilever and Starbucks, respectively

We demonstrate this in Figure 31in which we show, given our assumptions, what 1pt of sales growth is worth in terms of profit dollars for each category. The operating profit is

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most sensitive to CSD because of its favorable margin structure and least sensitive to water. This also demonstrates that sports drinks are the most important category for PepsiCo and a significant contributor to profit growth.

Figure 31: The Profit Contribution Given 1pt of Sales Growth Is Most Significant for CSD and Least so for Tea and Water

Impact on Profit $ Growth Margin

CSD 30.4 43 bps 2 bpsSports Drinks 10.6 25 bps 3 bpsTea 0.2 4 bps 0 bpsJuice 0.5 6 bps (2 bps)Coffee 0.4 5 bps 1 bpsWater 0.1 3 bps (1 bps)

Source: Credit Suisse estimates.

In addition, we have attempted to understand how much NCBs must grow as CSD declines to maintain an even operating margin. Given our sales growth range assumptions, we figure PepsiCo will expand North America Beverage margins over the coming years. This analysis uses our growth and margin assumptions by category and plays out a number of scenarios, solving for the margin-neutral mix given a CSD growth rate (decline). This margin-neutral growth mix is represented by the curve such that any point plotted above and to the right is margin accretive and any point below and to the left is margin dilutive.

Figure 32: Margin Impact of CSD and NCB Growth Scenarios; Our Estimates Suggest PepsiCo's Will Expand Margins over the Coming Three Years

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Source: Credit Suisse estimates.Note: all scenarios above the curve are operating margin accretive, all scenarios below the curve are operating margin dilutive

To achieve the algorithm shown in Figure 32, the segment would need to grow at the rate represented by the orange dot below (CSD grows 0%, NCB grows 5%).

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International Beverages Not Benefiting Fully from Category Growth Internationally, CSD Are Still Growing at a Lower Rate than NCBs

Figure 33: NCBs Are Outpacing CSDs Internationally

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LTM International Category Growth

NCB CSD

Source: Nielsen International, Credit Suisse.

CSD Market Share Is Significantly Behind Competition in All Major International MarketsApart from the Middle East region (from Egypt to Pakistan) where Pepsi is the leading CSD player, CSD market shares are much lower than its competition.

In Europe, the 11.6% market share is mostly driven by the United Kingdom, which represents 65% of the $1B PepsiCo CSD retail sales according to Nielsen. The United Kingdom is PepsiCo's CSD best-in-class country in Europe, with shares of 19.7% and growing; the balance of Europe is generally in the low- to high-single digits.

Generally speaking, Western Europe, Africa (except a few countries including Egypt and Nigeria), and Latin America are the weak points of PepsiCo's CSD portfolio. According to Nielsen, PepsiCo's CSD share of 4% in a country such as Brazil, where the CSD business is the largest outside of the United States ($9.3B), just highlights the missed opportunity for PepsiCo and the free ride that Coke is enjoying.

Figure 34: PepsiCo Underperforming Coke CSD Internationally

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To put everything into perspective, the size of the CSD market across the world has very little to do with the size of inhabitants per market. Per capita consumption varies a lot across the world, from very low in China to much higher in the United States and Mexico.

Figure 35: Relative to Population, LAR per Cap Is High, While Asia Is Very Low and Europe Is in the Middle

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The Picture Improves on the NCB Front, with Some Pockets of Strength Such as in Europe What PepsiCo has not been able to replicate internationally is the NCB market advantage it has built in the United States, with a few exceptions such as Europe.

Europe, the stronghold of the Pepsi-Lipton joint venture, has benefited from the failure of the Coke partnership with Nestle (Nestea) to achieve nearly 20% of the tea category. Tropicana is the leading chilled juice brand in Western Europe, but it has started to suffer from the success of Innocent (bought by Coke in 2013) that has eroded its share, especially in the United Kingdom. One of the testaments of the success of Tropicana and Lipton is their inclusion in McDonald's menus in Europe, a customer for which Coca-Cola is usually exclusive.

The tea partnership with Unilever is probably the most successful piece of the international NCB business, but it's still on a small scale if you consider the major tea countries, such as China or Japan, are poorly penetrated by Lipton. Moreover, apart from Europe, Lipton is behind competition in markets such as Latin America, where the brand didn't benefit from the first-mover advantage and lags Coke's tea brand in Brazil (11% versus 70%) and Mexico (13% versus 58%, with Arizona also at 13%).

Water is the largest NCB business internationally, representing almost 45% of the total NAB business (versus 25% in the United States). In developing and emerging countries where processed water such as Aquafina has significant shares of the water business, PepsiCo is lagging, with 9% share in India versus Coke at 17% and 11% share in Russia (down 2pts year over year).

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Historic, Structural, and Executional ReasonsCoke in most countries had the first-mover advantage entering into most of the international markets. This led to some scale and structural deficit for PepsiCo only a large investment could fix or with the help from an external partner.

■ Bottling Network: It is probably a side effect of a late entry, but PepsiCo doesn't have a bottling network able to match Coke's. PepsiCo has a few anchor bottlers, but its top five is far from representing the 48% of its business that the Coke bottlers represent for KO. This creates a scale deficit. Moreover, what Coke has that Pepsi rarely has is a bottling network focused 100% on selling just its products. None of PepsiCo's largest bottlers are exclusively dedicated to sell PepsiCo beverages products. Ambev, Suntory, Kirin, Tinghy, or Britvic have a core line of products outside soft drinks (beer, spirit, and noodles) that require their utmost attention or they sell lines of products that can sometimes be competitive to PepsiCo products (e.g., Britvic juices in the United Kingdom and Guarana Antarctica CSD at Ambev Brazil).

■ Brands' Global Expansion or Lack Thereof: 7UP inherently can't be global (owned by Dr Pepper Snapple in the United States), but it doesn't help to build global marketing scale and platform especially when the largest country is not on board. Gatorade, despite its undisputable U.S. leadership and legitimacy with the Gatorade Sports Science Institute, has seen limited international expansion since PepsiCo acquired it in December 2000. Mtn Dew's uniqueness and clear brand positioning has not yet been leveraged internationally and is potentially now at the mercy of Monster's Mutant international launch. International successes have similarly been slow at exporting across regions: Pepsi Max was slow to roll out and conceded Coke Zero first mover advantage and later market leadership despite a successful launch in Europe years ahead, for example.

■ Lack of Investment Behind Brands in Comparison with Competition: Coke spends significantly more on advertising than PepsiCo in terms of dollars and as a percent of sales, which all goes to beverages, compared with PepsiCo for which we assume at least the fair share of those dollars goes to Frito-Lay and Quaker.

Figure 36: Coke Outspends PepsiCo in % of Sales and Even More in Advertising Dollars Owing to the Scale Advantage

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■ Execution: When asked if country managers were incentivized to push certain strategic or priority brands (we mentioned specifically Gatorade or Mtn Dew), management told us that regional managers are compensated based on their own country/region P&L targets, and it is up to them to decide how best to reach those numbers. It seems there is neither a mandate nor incentive for a local general manager to roll out specific global initiatives. That to us is a different approach to operate if we compare it with Coke, which is more directive.

■ Trouble Gaining Traction in On-Premise Internationally: Most of the U.S. accounts (QSR is a U.S. industry) are global, and Coke can leverage its U.S. advantage globally and build local-scaled businesses on the back of those customers, with the exception of Yum! Brands (Pizza Hut, Taco Bell, and KFC). To our knowledge, no other large restaurant chain is pouring Pepsi globally, and the lack of strong and focused network of bottlers could be a handicap for new business acquisitions.

Figure 37: PepsiCo Is in in Only Four of the Top Ten Foodservice Accounts, Two of Which It Shares with CokeAccount Cola

Subway CokeMcDonalds CokePizza Hut Pepsi ←7-Eleven Coke / Pepsi ←Dunkin' Donuts CokeBurger King CokeTaco Bell Pepsi ←Wendy's CokeDomino's Pizza CokeDairy Queen Coke / Pepsi ←

Source: Beverage Digest, Credit Suisse.

There Is No Easy Fix for PEP's International Beverage Business The following options could be envisaged;

■ Option One: The status quo would be international business remains as is and the outcome should not change.

■ Option Two: The U.S. playbook could be replicated internationally, with PepsiCo buying local bottlers and bottler rights, or not renewing those rights at the expiration of existing contracts, essentially operating as it does in the United States.

■ Option Three: This would be the same as option two, but PepsiCo would leverage Frito-Lay's international strength to distribute beverages.

■ Option Four: Another company that has the resources to manufacture, distribute, and invest behind the brands buys out PepsiCo.

We think options one and four are the only we could envisage. Options two and three would require so much reinvestment in the brands and infrastructure, plus complications dealing with hundreds of bottlers one by one, that we think these are most unlikely. Moreover, the most recent moves internationally have been to go the other way and refranchise. Option one is the most likely in our view (embedded in our valuation assumptions).

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Algorithm and Valuation Driven by Food and Improvement of U.S. Beverages To fully assess the value of the food business for PepsiCo including international, we stripped away the FX and Venezuela deconsolidation from the numbers. Results are that 59% of our PepsiCo sales growth forecast should come from the food side of the business and 57% of the company profits.

We start by attempting to isolate the FX impact and look at core results. The volatile currency markets have had a significant impact on the sales mix of the overall business. International sales have declined from $29.6B in 2013 to a projected $23.0B in 2016. This represents a decrease to around 37% of total sales from nearly 45% just three years ago. However, our math suggests that this has been driven entirely by FX. In fact, if we strip out the cumulative currency impact over the period, international sales would still constitute around 45% of the currency-neutral total. Over the same period, currency-neutral international sales have increased at around 4% annually compared with 3% for North America, mainly driven by food.

Figure 38: On an Organic Basis, We Estimate the Global Food Business Will Contribute 59% of the Company's Sales Growth Through 2018…

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Figure 39: … and 57% of Its Profits

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We estimate that PepsiCo food (FLNA and QFNA) will generate around $4B of free cash flow in FY16, more than half of the company total.

Figure 40: Frito-Lay North America Constitutes Most of the FCF Generation and Enterprise Valuation

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Relative Value of the Operations In terms of fundamentals and valuation, we think the many positives of PepsiCo outweigh the negatives.

PepsiCo EV is largely driven by its global food business (primarily Frito-Lay), representing 64% of the $216B food and beverage total EV, according to our methodology. We value Coke very similarly at $210B, but that is primarily driven by the international beverage

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business. Figure 41 depicts the component parts of our valuation framework and how they compare across the two companies. We think investors often compare Coke and PepsiCo directly, but each derives its value quite differently. We think this is the primary reason the market is currently undervaluing PepsiCo shares.

In aggregate, our relative framework follows this logic:

■ We value PepsiCo NA Beverage at parity with Coke NA around $61B each; PepsiCo is underperforming in the declining CSD category but outperforming in growing NAB segments

− We apply a higher multiple to Coke's NA business (17x) than we do to PepsiCo's North America Beverages (15x). PepsiCo is more than twice the size of Coke in terms of sales, but Coke's profit margins are nearly double those of Pepsi. We think these offset so the two are worth approximately the same enterprise value.

■ We value PepsiCo's international beverage business by allocating 36% (in-line with beverage's fair share of international sales) of the total international EV as derived using our SOTP, implying a significantly lower value than that of Coke's international business; Coke has commanding CSD market share in nearly every major market around the world, but PepsiCo has some pockets of strength in NCBs. Moreover, CSD is still growing internationally, and Coke relies on a much stronger bottling network to harvest any CSD business opportunities.

− Coke is the clear winner in terms of valuation multiples, size, scale, margins, and enterprise value.

■ PepsiCo's global food business makes up the difference; we estimate the combined Frito-Lay and Quaker businesses are worth around $138B and drive the majority of PepsiCo's enterprise value. We have benchmarked Frito-Lay and Quaker against Mondelez and Kellogg, respectively.

Figure 41: PepsiCo's EV Is Driven Largely by the Global Food Business

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Pepsi Coke

34%18% 49%18% 27%EBITDA Margin

Source: Company data, Credit Suisse estimates. Note: does not incorporate corporate costs or the value of Coke's equity investments

15 September 2016


ValuationOur $121 target price assumes a 22x P/E on our discounted CY18 EPS estimate. This is a full-turn discount to the level at which we value KO and a 2% premium to the level at which the U.S. Staples currently trade compared with a 7% historical discount.

Relative to Coca-Cola (KO), we think the company should trade at a discounted multiple owing to Coke's new asset-light, lower-risk model. To support this, we looked at the restaurant industry and found that the highly franchised models (especially within QSRs) tend to trade at higher multiples than the ones with more company-owned locations. This tends to hold true in terms of P/E but even more so for EV/EBITDA. Therefore, we think it is fair to value PEP at a discount to Coke on a P/E basis and a steeper discount on an EBITDA basis owing to the structurally lower depreciation expense associated with the nearly fully franchised model.

Our SOTP analysis supports our valuation, assuming the following:

■ FLNA at 17x; a premium to Mondelez (~15.5x)

■ QFNA at 14x; a premium to Kellogg (~13x)

■ NAB at 15x; this is a premium to the level at which we value DPS owing to the relative strength of the NCB portfolio but a discount to the level at which we value Coke North America for the reason described earlier in this report

■ LA at 12x; a discount to North America Beverages owing to Coke's relative dominance in Latin America but a premium to the rest of the international because of the strength of the Gamesa and Sabritas snack brands

■ ESSA at 10x; a discount to the rest of international operations owing to weakness in Russia

■ AMENA at 11x; premium to ESSA but discount to LA because of weakness in China

Figure 42: Our SOTP Supports Our Target Price

Sum of the Parts CS FY18E Value

($ in millions) Sales ($) EBITDA ($) Margin (%) EBITDA (x) Ent V ($) Notes

Frito-Lay North America 16,298 5,601 34% 17.0x 95,225 Prem to Mondelez, Prem to NA BevQuaker Foods North America 2,612 788 30% 14.0x 11,032 Premium to KelloggNorth America Beverages 21,975 4,037 18% 15.0x 60,548 Prem to DPS at 13x; Disc to Coke NA 17xLatin America 7,343 1,415 19% 12.0x 16,979 Disc to US; Prem to other Int'l b/c Gamesa/SabritasEurope, Sub-Saharan Africa 10,268 1,619 16% 10.0x 16,191 Disc to Int'l average bc Russia troublesAsia, Middle East, North Africa 6,953 1,437 21% 11.0x 15,809 Prem to Europe, Disc to LA b/c of China troublesCorporate 0 (706) NA 15.0x (10,593) Segment average

Total 65,450 14,191 22% 14.5x 205,190

Less: Current Net Debt 25,975Total Equity Value 179,215

Current Shares 1,456Value per Share 1 $121

1. Discounted back 0.3 years from FY18 to represent the expected stock price using a NTM multiple, one-year from today


15 September 2016


Figure 43: PEP Currently Trades at a 4% Discount to U.S. Staples, Slightly Ahead of the Historical Average Discount

(20%)

0%

20%

5x

10x

15x

20x

25x

Sep 08 Sep 09 Sep 10 Sep 11 Sep 12 Sep 13 Sep 14 Sep 15 Sep 16

Pre

miu

m /

(Dis

coun

t) to

Pee

rs (%

)

Abs

olut

e M

ultip

le (x

)

PEP P/E [Left] PEP Prem / (Disc) to Peers [Right] 2-yr Rolling Avg [Right]

Source: Thomson Reuters, Credit Suisse.

Figure 44: PepsiCo's TSR Has Outpaced KO by a Significant Margin and Performed Generally In-Line with the S&P 500 over a Three-Year Period

18%

12%

6% 6%

10%

14%

0%

4%

8%

12%

16%

20%

1-year 3-year

Ann

ualiz

ed S

hare

hold

er R

etur

n (%

)

Annualized Shareholder Return

PEP KO S&P

Source: Thomson Reuters, Credit Suisse.Note: S&P500 represents the SPDR S&P 500 ETF Trust ("SPY") as a proxy for owning the index

15 September 2016


Risks to Our ThesisIncreased RegulationThe debate as to whether sugar is the next tobacco is older than we can remember. Despite numerous attempts at limiting consumption of sweetened drinks and snacks by regulators around the world, consumers continue to enjoy these products, and global volume growth for the most part remains stable, although it is declining in many developed markets.

Philadelphia recently passed a sweetener beverage tax, which could open the door for other major municipalities to try. This previously failed in New York City under Mayor Michael Bloomberg, but we wouldn’t be surprised if the city government tries again now that the tax in Philadelphia passed.

That said, we see little reason to support the argument that CSD stocks should trade at a discount as a result of regulatory risk factors. Such regulations may have temporary impacts on volumes (as seen in Mexico), but sales tend to recover relatively quickly. The negative press about sugar and artificial sweeteners is not new news; therefore, we don’t think volume declines would accelerate given this additional external pressure.

Declining CSD Category in the United StatesCSD volumes have been falling for over a decade, and the trend has deteriorated further over the past few years. The media, particularly in the United States, has been drawing negative attention over the high sugar content of regular CSDs, which has exacerbated consumers’ negative perceptions about the category overall. In addition, health concerns related to artificial sweeteners has had an impact on the diet segment. Even though anemic CSD growth continues to be a drag in the United States, innovation in select segments has been a positive.

Global Political and Macroeconomic ConcernsMany of the countries in which PepsiCo operates have experienced and continue to experience unfavorable economic conditions. In addition, civil unrest or other political developments could have a significant negative impact on sales. This has been seen before. For example when riots occurred in Egypt, demand fell by an estimated 30%.

In addition, the risk of government intervention in certain markets could pose a significant threat to PepsiCo. We believe this has been present in other categories across food and beverage like in the baby formula market. This could be especially true for Frito-Lay that tends to own the markets where it operates.

15 September 2016


Company BackgroundDescriptionBusiness OverviewPepsiCo Inc. is a leading global food and beverage company, established in 1965 through a merger of Pepsi-Cola and Frito-Lay. Today PepsiCo has a diverse portfolio of complimentary food and beverages that includes 22 brands that each generated more than $1 billion in retail sales in 2015. Its popular brands are Frito-Lay, Gatorade, Pepsi-Cola, Quaker, and Tropicana. The company manufactures, markets, and distributes its products independently and in conjunction with third parties in more than 200 countries.

Figure 45: PepsiCo Sales by Segment Figure 46: PepsiCo Profit by Segment

FLNA23%

QFNA4%

NAB33%

LA13%

ESSA17%

AMENA10%

FLNA39%

QFNA5%

NAB25%

LA11%

ESSA11%

AMENA9%

Source: Company data, Credit Suisse. Source: Company data, Credit Suisse.

The company's operations are divided into 6 reporting segments:

■ Frito-Lay North America (FLNA): Frito-Lay North America makes, markets, distributes, and sells branded snack food that includes Lay's potato chips, Doritos tortilla chips, Cheetos, Tostitos, and Ruffles. The segment reported $14.8 billion in revenues that represented 23% of the company's total revenues in 2015.

■ Quaker Foods North America (QFNA): Quaker Foods North America makes, markets, distributes, and sells cereals, rice, pasta, and other branded products. The popular brands under this segment include Quaker oatmeal, Aunt Jemima mixes and syrups, Quaker Chewy granola bars, Cap’n Crunch cereal, and Quaker grits. This division reported net revenues of $2.5 billion in 2015.

■ North America Beverages (NAB): This segment manufactures, markets, distributes and sells beverage concentrates, fountain syrups, and finished goods. The popular beverage brands are Pepsi, Gatorade, Mountain Dew, Diet Pepsi, Aquafina, Diet Mountain Dew, Tropicana Pure Premium, Sierra Mist, and Mug. This division also manufactures and distributes certain brands under joint venture or licensed agreement with Unilever, Starbucks, Dr Pepper Snapple, Dole Food Company, and Ocean Spray Cranberries Inc. The segment reported net revenues of $20.6 billion that represents 33% of the company's total revenues in 2015.

15 September 2016


■ Latin America (LA): The Latin America division makes, markets, distributes, and sells branded snacks, Quaker-branded cereals, beverage concentrate, fountain syrups, and finished goods in Latin America. Latin America also sells ready-to-drink tea through an international joint venture with Unilever (under the Lipton brand name). Latin America’s net revenue was $8.2 billion in 2015

■ Europe Sub-Saharan Africa (ESSA): Europe Sub-Saharan Africa makes, markets, distributes, and sells branded snacks, Quaker- branded cereals, beverage concentrate, fountain syrups, and finished goods in Europe Sub-Saharan Africa. The popular brands are Lay's Kurkure, Chipsy, Doritos, Pepsi, Mirinda, 7UP, Diet Pepsi, and Tropicana. This division also makes, distributes, and sells ready-to-drink tea products through an international joint venture with Unilever and some leading dairy products such as Chudo, Agusha, and Domik. The division reported net revenue of $10.5 billion in 2015.

■ Asia, Middle East, and North Africa (AMENA): The Asia, Middle East, and North Africa division makes, markets, distributes, and sells branded snacks, Quaker--branded cereals, beverage concentrate, fountain syrups, and finished goods. The popular brands are Lay's Kurkure, Chipsy, Doritos, Pepsi, Mirinda, 7UP, Diet Pepsi, Mountain Dew, Aquafina, and Tropicana. The division accounted for $6.4 billion of revenues, which represented 10% of the company's revenues in 2015.

Distribution and CustomersPepsiCo products are distributed through direct store delivery (DSD), customer warehouse, and distributor networks.

■ Direct Store Delivery: The company manufactures its products independently or through independent bottlers. The bottlers and distributors in turn operate direct store delivery mechanisms to deliver beverages, foods, and snacks directly to retail stores at which the products are merchandised by company employees.

■ Customer Warehouse: This distribution system is usually used for products that are less fragile and perishable. Under this system, the products are delivered from the company's manufacturing plants and warehoused to customer warehouses.

■ Distributor Networks: The company distributes many of its products through third-party distributors. Third-party distributors are effective in achieving greater distribution reach by including a wide range of products on the delivery vehicles.

The company's top five retail customers constituted approximately 32% of revenue in North America, with Wal-Mart representing approximately 18%.

GovernanceManagement Team ■ Indra K. Nooyi (60)—Chairman and Chief Executive Officer: Indra Nooyi has been

the chairman of PepsiCo's board of directors since 2007 and chief executive officer of the company since 2006. Prior to becoming CEO, she served as president and chief financial officer beginning in 2001. She joined Pepsi in 1994 from Asea Brown Boveri for which she was vice president of strategy and strategic marketing. She received a B.S. from Madras Christian College, an M.B.A. from the Indian Institute of Management in Calcutta, and a Master of Public and Private Management from Yale University.

■ Hugh Johnston (54)—Vice Chairman of Board and Chief Financial Officer: Mr. Johnston is vice chairman of the board, executive vice president and chief financial officer at PepsiCo. He was appointed CFO in March 2010, and prior to that, he was

15 September 2016


responsible for company’s global e-commerce business and Quaker Foods North America division. He joined PepsiCo in 1987 and has held various leadership positions.

■ Albert P. Carey (64)—Chief Executive officer, North America: Mr. Albert is a chief executive officer of North America responsible for leading North American Beverages, Frito-Lay North America, and Quaker Foods North America. He joined PepsiCo in 1991 from Procter and Gamble and has served variety of leadership positons. He received a Bachelor of Science in Government and Politics from the University of Maryland.

■ Sanjeev Chadha (56)—Chief Executive Officer-Asia Middle East and North Africa: Mr. Sanjeev Chadha is chief executive officer of the company for its operations in Asia, Middle East, and North Africa. Prior to his current role, he has served as chief executive officer of PepsiCo's Middle East and Africa region.

■ Ramon Laguarta (52)—Chief Executive Officer, Europe Sub-Saharan Africa: Mr. Ramon is chief executive officer, Europe Sub-Saharan Africa leading the food and beverages business across Europe and the food business in Sub-Saharan Africa. Ramon received an MBA from ESADE Business School in Spain and a master's in international management from Thunderbird School of Global Management, USA.

■ Laxman Narasimhan (48)—Chief Executive Officer, Latin America: Mr. Laxman is chief operating officer of PepsiCo Latin America. He leads PepsiCo's food and beverage business across Latin America. Prior to PepsiCo, he was director and location manager of McKinsey's New Delhi Office. He received a degree in mechanical engineering and an MBA from The Wharton School at The University of Pennsylvania.

Executive Compensation■ CEO: Weighted 100% PepsiCo based on targets for organic revenue, EPS, core net

ROIC, and cash flow

■ CFO: Weighted 100% PepsiCo based on targets for organic revenue, cash flow, share of retail sales, and net income

■ Division CEO's: Weighted 100% to their division based on targets for organic revenue, cash flow, share of retail sales, and net operating profit before tax

15 September 2016


HOLT® AnalysisFigure 47: HOLT P/B vs. CFROI® Scatter Chart

Source: Company data, HOLT.

Figure 48: Growth vs. CFROI Bubble Chart


15 September 2016


Figure 49: HOLT Condensed RWC Chart


PEP Segment CFROI & Drivers: FLNA and QFNA have extremely high returns due to margins and asset efficiency. NAB under-earns relative to LATAM, but is higher than Europe (ESSA) and AMENA. FLNA and AMENA have seen the highest reinvestment in the business (asset growth)

Figure 50: Segmental Benchmarking


The CFROI® chart at the top of Figure 51 is a reflection of our forecasts for sales, margins and asset turns. Our forecasts from 2016 to 2018 suggests margin expansion of c.100 bps and improvement in top line growth to 3.6% leading to returns level averaging at c.16%

From a valuation perspective, we use a 20-year explicit forecast window for PEP. Over the long term we normalize nominal sales growth to c.4% in line with the industry. Given this

15 September 2016


assumption, the market is pricing in c.200 bps improvement in EBITDA margins over the next 20 years to reach c.21% by 2035.

Beyond the explicit 20-year window for PEP, HOLT assumes the CFROI and discount rate fade to 6.0%, while the asset growth fades to 2.5%—incorporating the economic reality of competition and causing returns and growth to regress to the mean.

Figure 51: HOLT—Credit Suisse Analyst Scenario Data

Current Price: USD 105.05 Warranted Price: USD 105.25 Valuation date: 15-Sep-16

Warranted upside/downside sensitivity to growth and margins Summary of CS Research projections and key operating driversLong term sales growth Dec 14A Dec 15A Dec 16E Dec 17E Dec 18E

USD 1.9% 2.9% 3.9% 4.9% 5.9% Sales Growth, % 0.4 -5.4 -1.1 1.6 3.3EBITDA Mgn, % 19.0 19.8 20.3 21.2 21.7Asset Turns, x 1.06 1.0 0.9 0.9 0.9

CFROI®, % 17.2 15.6 16.1 16.2 16.6Disc Rate, % 4.3 4.1 3.4 3.4 3.4Asset Grth, % -6.0 0.4 2.1 0.8 1.0

Value/Cost, x 4.0 4.2 4.5 4.4 4.1Economic PE, x 23.1 26.7 28.1 27.0 25.0Leverage, % 21.6 23.8 22.8 23.1 22.3

HO

LT

- C

redi

t Sui

sse

Ana

lyst

Sce

nari

o D

ata

PEPSICO INC (PEP)

Long

term

EBI

TDA

mar

gins

19.0% 59.7 71.3 85.1 101.5

147.5

121.3

20.0% 67.6 80.2 95.2 113.0 134.4

21.0% 75.4 89.1 105.2 124.5

173.6

22.0% 83.3 98.0 115.3 135.9 160.5

23.0% 91.2 106.9 125.4 147.3

More than 10%

downsideWithin 10% More than

10% upside

Source: Credit Suisse HOLT®

Source: Credit Suisse HOLT®. CFROI and HOLTare trademarks or registered trademarks of Credit Suisse Group AG or its affiliates in the United States and other countries.

02468

101214161820

2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035Historical Forecast based on Research projection

Long term projections Discount Rate

CFROI & Discount Rate (in %)

0

5

10

15

20

25

2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035Historical Forecast based on Research projection Implied by current market price

EBITDA Margin (in %)

-10

-5

0

5

10

15

20

2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035

Historical Forecast based on Research projection Long term projections

Sales Growth (in %)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035

Historical Forecast based on Research projection Long term projections

Asset Turns (x)

Source: company data, credit suisse estimates.

15 Septem

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PepsiCo, Inc. (PEP)

37

Figure 52: Income StatementIncome Statement 2015 2016($US in millions, except per share) FY12 A FY13 A FY14 A 1QA 2QA 3QA 4QA FY15 A 1QA 2QA 3QE 4QE FY16 E FY17 E FY18 E

Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 Sep 16 Dec 16

Net Sales 65,492 66,415 66,683 12,217 15,923 16,331 18,585 63,056 11,862 15,395 15,723 19,402 62,382 63,373 65,450 y-o-y growth % (1.5%) 1.4% 0.4% (3.2%) (5.7%) (5.2%) (6.8%) (5.4%) (2.9%) (3.3%) (3.7%) 4.4% (1.1%) 1.6% 3.3%

Costs of Goods Sold 31,316 31,161 30,917 5,485 7,253 7,376 8,397 28,511 5,169 6,893 7,060 8,731 27,853 28,059 28,848 Gross Profit 34,176 35,254 35,766 6,732 8,670 8,955 10,188 34,545 6,693 8,502 8,663 10,671 34,530 35,314 36,602

Gross Margin 52.2% 53.1% 53.6% 55.1% 54.4% 54.8% 54.8% 54.8% 56.4% 55.2% 55.1% 55.0% 55.4% 55.7% 55.9%

Selling, General, and Admin 24,375 25,083 25,361 4,882 5,765 6,046 7,840 24,533 4,703 5,572 5,903 8,123 24,302 24,381 25,015 Amortization of Intangibles 119 110 92 16 19 18 22 75 14 17 15 15 61 63 65 Other Expenses / (Income) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Total Operating Expenses 24,494 25,193 25,453 4,898 5,784 6,064 7,862 24,608 4,717 5,589 5,918 8,138 24,363 24,443 25,079 SG&A Margin 37.4% 37.9% 38.2% 40.1% 36.3% 37.1% 42.3% 39.0% 39.8% 36.3% 37.6% 41.9% 39.1% 38.6% 38.3%

Operating Profit 9,682 10,061 10,313 1,834 2,886 2,891 2,326 9,937 1,976 2,913 2,745 2,533 10,167 10,870 11,523 Operating Margin 14.8% 15.1% 15.5% 15.0% 18.1% 17.7% 12.5% 15.8% 16.7% 18.9% 17.5% 13.1% 16.3% 17.2% 17.6% y-o-y growth % (6.6%) 3.9% 2.5% (2.0%) (2.4%) (1.9%) (8.3%) (3.6%) 7.7% 0.9% (5.1%) 8.9% 2.3% 6.9% 6.0%

EBITDA 12,371 12,724 12,938 2,330 3,465 3,460 3,098 12,353 2,457 3,476 3,377 3,384 12,694 13,448 14,190 EBITDA Margin 18.9% 19.2% 19.4% 19.1% 21.8% 21.2% 16.7% 19.6% 20.7% 22.6% 21.5% 17.4% 20.3% 21.2% 21.7% y-o-y growth % NA 2.9% 1.7% (3.0%) (3.4%) (3.4%) (8.0%) (4.5%) 5.5% 0.3% (2.4%) 9.2% 2.8% 5.9% 5.5%

Net Interest Expense 894 911 909 211 217 225 317 970 246 255 258 258 1,018 1,033 1,033 Interest (Income) and Other (91) (97) (85) (15) (14) (2) (28) (59) (14) (22) (12) (13) (60) (68) (72)

Pretax Income 8,879 9,247 9,489 1,638 2,683 2,668 2,037 9,026 1,744 2,680 2,498 2,288 9,210 9,905 10,561 Income Taxes 2,389 2,377 2,375 377 697 657 458 2,189 430 698 612 516 2,256 2,427 2,588

Tax Rate 26.9% 25.7% 25.0% 23.0% 26.0% 24.6% 22.5% 24.3% 24.7% 26.0% 24.5% 22.6% 24.5% 24.5% 24.5%

Non-controlling Interests 36 47 48 10 14 10 15 49 14 11 15 15 55 60 60 Net Income to Common 6,454 6,823 7,066 1,251 1,972 2,001 1,564 6,788 1,300 1,971 1,871 1,756 6,898 7,418 7,914

Adj Diluted EPS $4.10 $4.37 $4.63 $0.83 $1.32 $1.35 $1.06 $4.57 $0.89 $1.35 $1.29 $1.22 $4.75 $5.19 $5.62 y-o-y growth % (6.9%) 6.8% 5.8% 0.8% (0.0%) (1.0%) (4.6%) (1.3%) 7.1% 2.4% (4.2%) 14.5% 4.1% 9.2% 8.2%

Diluted Shares Oustanding 1,576 1,561 1,528 1,503 1,491 1,483 1,470 1,487 1,459 1,456 1,448 1,441 1,451 1,429 1,409

Sales BreakdownVolume 1% 0% 1% 0% (0%) 1% 1% 1% 2% 2% 1% 2% 2% 2% 2% Price / Mix 4% 4% 3% 4% 5% 6% 4% 5% 2% 2% 2% 2% 2% 2% 2% Acquisitions / (Divestitures) (3%) (1%) (0%) 0% (1%) (0%) (0%) (0%) (0%) (0%) 0% 0% (0%) 0% 0% Currency (2%) (2%) (3%) (8%) (10%) (12%) (8%) (10%) (4%) (4%) (5%) (4%) (4%) (0%) 0% Extra week / other (1%) 0% 0% 0% 0% 0% (2%) (1%) (2%) (3%) (2%) 5% (0%) (1%) 0%

Net Sales Growth (2%) 2% 0% (3%) (6%) (5%) (7%) (5%) (3%) (3%) (4%) 4% (1%) 2% 3% Organic Growth 5% 4% 4% 4% 5% 7% 4% 5% 3% 3% 3% 4% 3% 4% 3%


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PepsiCo, Inc. (PEP)

38

Figure 53: Balance Sheet Figure 54: Cash Flow StatementBalance Sheet($US in millions, except per share) FY12 A FY13 A FY14 A FY15 A FY16 E FY17 E FY18 E

Cash 6,297 9,375 6,134 9,096 11,024 11,734 12,556 Accounts Receivable 7,041 6,954 6,651 6,437 6,294 6,639 6,070 Inventories 3,581 3,409 3,143 2,720 3,023 2,947 3,126 Other Current Assets 1,801 2,465 4,735 4,778 4,367 4,436 4,582

Total Current Assets 18,720 22,203 20,663 23,031 24,708 25,757 26,333

Property, Plant & Equipment 19,136 18,575 17,244 16,317 16,670 17,023 17,382 Goodwill 16,971 16,613 14,965 14,177 14,398 14,398 14,398 Other Intangibles 16,525 16,039 14,088 13,081 13,301 13,222 13,141 Other Assets 3,286 4,048 3,549 3,061 2,869 2,869 2,869

Total Assets 74,638 77,478 70,509 69,667 71,946 73,269 74,123

Accounts Payable 11,903 12,533 13,016 13,507 13,019 13,704 13,771 Short-term Debt 4,815 5,306 5,076 4,071 4,774 4,774 4,774 Other Current Liabilities 371 0 0 0 0 0 0

Total Current Liabilities 17,089 17,839 18,092 17,578 17,793 18,478 18,545

Long-Term Debt (incl Current) 23,544 24,333 23,821 29,213 30,847 30,847 30,913 Deferred Tax Liability 5,063 5,986 5,304 4,959 5,156 5,156 5,156 Other Liabilities 6,543 4,931 5,744 5,887 5,793 5,593 5,393

Total Liabilities 52,239 53,089 52,961 57,637 59,589 60,074 60,006

Total Common Equity 22,417 24,409 17,578 12,068 12,376 13,215 14,136

Minority and Mez Interests (18) (20) (30) (38) (19) (19) (19)Total Equity 22,399 24,389 17,548 12,030 12,357 13,196 14,117

Net Debt 22,062 20,264 22,763 24,188 24,597 23,887 23,131

Cash Flow Statement($US in millions, except per share) FY12 A FY13 A FY14 A FY15 A FY16 E FY17 E FY18 E

Net Income 6,214 6,787 6,558 5,501 6,585 7,418 7,914 Depreciation 2,570 2,553 2,533 2,341 2,450 2,499 2,586 Amortization 119 110 92 75 77 79 81 Impairments 0 0 0 0 0 0 0 Changes in Working Capital 442 923 708 987 6 345 312 Changes in Other LT Accounts (8) 35 451 5 502 0 0 Stock-based Comp Expense 278 303 297 295 300 300 300 Pension Contributions (1,865) (262) (655) (205) (235) (200) (200)Other 729 (761) 522 1,581 326 0 0 Cash Flow from Operations 8,479 9,688 10,506 10,580 10,011 10,441 10,994

Capital Expenditures (2,714) (2,795) (2,859) (2,758) (2,807) (2,852) (2,945)Sale of Fixed Assets 95 109 115 86 47 0 0 Acquisitions (153) 21 115 (10) 71 0 0 Other (233) 40 (2,308) (887) (807) 0 0 Net Investing Cash Flow (3,005) (2,625) (4,937) (3,569) (3,496) (2,852) (2,945)

Cash Available for Financing 5,474 7,063 5,569 7,011 6,515 7,589 8,049 Free Cash Flow 5,765 6,893 7,647 7,822 7,204 7,589 8,049

per share 3.66 4.42 5.01 5.26 4.96 5.31 5.71

Change in ST Debt 0 0 0 2,819 0 0 Issuance of LT Debt 5,999 4,195 3,855 8,702 2,532 0 0 Repayment of LT Debt (2,449) (3,894) (2,189) (4,095) (3,083) 0 66 Common Dividends Paid (3,305) (3,434) (3,730) (4,040) (4,234) (4,525) (4,774)Issuance of Options 1,122 1,123 755 504 293 0 0 Treasury Stock Repurchases (3,226) (3,008) (5,022) (5,005) (2,979) (2,354) (2,519)Issuance of New Equity 0 0 0 0 0 0 0 Other (1,447) 1,229 (1,933) 106 78 0 0 Net Financing Cash Flow (3,306) (3,789) (8,264) (3,828) (4,574) (6,879) (7,227)

Foreign Exchange Effects 62 (196) (546) (221) (13) 0 0 Net Change in Cash 2,230 3,078 (3,241) 2,962 1,928 710 821

Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.

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Companies Mentioned (Price as of 14-Sep-2016)Anheuser-Busch InBev (ABI.BR, €108.95)Danone (DANO.PA, €64.74)Dominos Pizza (DPZ.N, $150.3)Dr Pepper Snapple Group (DPS.N, $90.28)Dunkin' Brands Group (DNKN.OQ, $48.24)Kellogg Company (K.N, $78.09)McDonald's Corp (MCD.N, $115.18)Mondelez (MDLZ.OQ, $42.54)Monster Beverage Corp (MNST.OQ, $142.9)Nestle (NESN.S, SFr77.5)PepsiCo, Inc. (PEP.N, $105.05, OUTPERFORM, TP $121.0)Starbucks (SBUX.OQ, $53.9)The Coca-Cola Company (KO.N, $42.11)The Kraft Heinz Company (KHC.OQ, $87.68)Unilever (ULVR.L, 3514.0p)Wendy's Company (WEN.OQ, $10.37)Yum! Brands, Inc. (YUM.N, $86.93)

Disclosure AppendixImportant Global Disclosures I, Laurent Grandet, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for PepsiCo, Inc. (PEP.N)

PEP.N Closing Price Target Price Date (US$) (US$) Rating 20-Sep-13 81.74 87.00 N 13-Feb-14 79.69 85.00 23-Jul-14 90.82 92.00 09-Oct-14 93.57 95.00 11-Feb-15 100.40 105.00 15-May-15 98.22 NR * Asterisk signifies initiation or assumption of coverage.

Target Price Closing Price PEP.N

1- Jan- 14 1- Jan- 15 1- Jan- 1670

80

90

100

110

N EU T RA LN O T RA T ED

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activitiesAs of December 10, 2012 Analysts’ stock rating are defined as follows:Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months.Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months.Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011.Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time.Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products.

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Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation:Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months.Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months.Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

Credit Suisse's distribution of stock ratings (and banking clients) is:

Global Ratings DistributionRating Versus universe (%) Of which banking clients (%)Outperform/Buy* 53% (50% banking clients)Neutral/Hold* 29% (24% banking clients)Underperform/Sell* 18% (44% banking clients)Restricted 0%*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and-analytics/disclaimer/managing_conflicts_disclaimer.htmlCredit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.

Target Price and RatingValuation Methodology and Risks: (12 months) for PepsiCo, Inc. (PEP.N)

Method: Our $121 target price for PEP assumes a 22x P/E multiple on our discounted CY18 EPS estimate. This represents a discount to KO but a premium to DPS. We think the market is currently underappreciating the value of the global food business with Frito-Lay and Quaker. We assign an Outperform rating because we think the risk-reward is favorable relative to our stock coverage.

Risk: Risk factors that could impede achievement of our $121 target price and cause us to lower our Outperform rating include 1) increased regulation, 2) accelerated declines of CSD category globally, 3) and global political and macroeconomic concerns.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names The subject company (PEP.N, KO.N, DPS.N, MNST.OQ, MDLZ.OQ, K.N) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse.Credit Suisse provided investment banking services to the subject company (KO.N, DPS.N, MDLZ.OQ) within the past 12 months.Credit Suisse has managed or co-managed a public offering of securities for the subject company (KO.N, DPS.N, MDLZ.OQ) within the past 12 months.Credit Suisse has received investment banking related compensation from the subject company (KO.N, DPS.N, MDLZ.OQ) within the past 12 monthsCredit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (PEP.N, KO.N, DPS.N, MNST.OQ, MDLZ.OQ, K.N) within the next 3 months.As of the date of this report, Credit Suisse makes a market in the following subject companies (PEP.N, KO.N, DPS.N, MNST.OQ, MDLZ.OQ, K.N).Credit Suisse has a material conflict of interest with the subject company (PEP.N) . Laurent Grandet was formerly employed by Pepsico Inc. within the past 12 months and received compensation from the company during that period.For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683. For date and time of production, dissemination and history of recommendation for the subject company(ies) featured in this report, disseminated within the past 12 months, please refer to the link: https://rave.credit-suisse.com/disclosures/view/report?i=246273&v=-6a8wq9d0ah3apnsf1pdfinvpj . Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report.The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events.Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares.

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Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report.For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.credit-suisse.com/sites/disclaimers-ib/en/canada-research-policy.html.Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (KO.N, DPS.N, MDLZ.OQ) within the past 3 years.Principal is not guaranteed in the case of equities because equity prices are variable.Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.This research report is authored by:Credit Suisse Securities (USA) LLC............................................................................................................Laurent Grandet ; Clay Crumbliss, CFAImportant Credit Suisse HOLT Disclosures With respect to the analysis in this report based on the Credit Suisse HOLT methodology, Credit Suisse certifies that (1) the views expressed in this report accurately reflect the Credit Suisse HOLT methodology and (2) no part of the Firm’s compensation was, is, or will be directly related to the specific views disclosed in this report.The Credit Suisse HOLT methodology does not assign ratings to a security. It is an analytical tool that involves use of a set of proprietary quantitative algorithms and warranted value calculations, collectively called the Credit Suisse HOLT valuation model, that are consistently applied to all the companies included in its database. Third-party data (including consensus earnings estimates) are systematically translated into a number of default algorithms available in the Credit Suisse HOLT valuation model. The source financial statement, pricing, and earnings data provided by outside data vendors are subject to quality control and may also be adjusted to more closely measure the underlying economics of firm performance. The adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across industries or national borders. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes the baseline valuation for a security, and a user then may adjust the default variables to produce alternative scenarios, any of which could occur.Additional information about the Credit Suisse HOLT methodology is available on request.The Credit Suisse HOLT methodology does not assign a price target to a security. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes a warranted price for a security, and as the third-party data are updated, the warranted price may also change. The default variable may also be adjusted to produce alternative warranted prices, any of which could occur.CFROI®, HOLT, HOLTfolio, ValueSearch, AggreGator, Signal Flag and “Powered by HOLT” are trademarks or service marks or registered trademarks or registered service marks of Credit Suisse or its affiliates in the United States and other countries. HOLT is a corporate performance and valuation advisory service of Credit Suisse.For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683.

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