Frito-Lay could heal PepsiCo's beverage wounds
Soda sales are taking a hit in North America and the company is looking to uphold its strong performance in the snacks business.
Pepsi's global CSD business has historically accounted for more than a fourth of the company's revenues, but has seen declining sales in recent times. On the other hand, the Frito-Lay North America division, which contributed only 20% to the total revenues in 2012, constitutes almost 35% of the company's valuation by our estimates.
We estimate a $87 price for PepsiCo, which is around 5% above the current market price.
Growing health awareness among consumers, particularly in the developed countries, has reduced CSD sales in the last few years.
In 2012, the U.S. CSD market declined by 1.2% year-on-year in terms of volume. The figure has further decreased by 2% in the nine months ending September this year. Studies have raised concerns over the unhealthy amount of sugar intake associated with juices and smoothies. As a result, beverage sales are taking a hit in North America and Pepsi is looking to uphold its strong performance in the snacks business in the region.
Frito-Lay more profitable
Frito-Lay North America forms more than a third of PepsiCo's valuation by our estimates. One of the main reasons for this is the heftier margins of this division, as compared to the beverage division. In 2012, while the company-wide margins stood at 20%, Frito-Lay North America had an impressive EBITDA margin of 33%.
Therefore, a higher proportion of Frito-lay sales in North America will be more profitable for Pepsi. The U.S. savory snack market was worth $29 billion in 2011, having grown at a CAGR of 5.1% since 2007. Looming health concerns such as obesity in the country have targeted the consumption of snacks with high calories and trans fats. However, snacks continue to be popular in North America, backed by the successful launches of healthier alternatives within the segment. The U.S. savory snacks market is expected to grow at a CAGR of 3.5% to reach ~$36 billion in annual revenues by 2016.
PepsiCo dominates snacks market
Although PepsiCo plays second fiddle to Coca-Cola in the U.S. beverage market, it has a formidable market share of over 35% in the savory snacks market. Within the savory snacks, PepsiCo has a stronghold in the potato chips, tortillas chips and corn snacks segments.
The potato chips market, in which Pepsi has a share of 58%, was worth ~$9 billion in 2012. Fueled by the introduction of baked and gluten-free chips, this market is expected to grow at a CAGR of 3.1% and reach annual revenues of over $10 billion by 2017.
Along with diversifying within its portfolio, Frito-Lay has also successfully expanded into other food divisions. Doritos Locos Tacos, which was launched in partnership with Taco Bell, has surpassed 0.6 billion unit sales since its launch last year.
Growth Potential Within The Market
In addition to the mid-tier segment comprising chips/crisps, corn snacks and tortillas, the premium and bottom ends of the U.S. snacks market also offer promising growth potential. According to Goldman Sachs, the premium end grew by 7% annually through 2010-11, and the bottom end is expected to grow by 4% annually in the next few years. Both these areas are growing at a faster rate compared to the overall snack market.
PepsiCo has identified the premium-priced products and value offerings for lower income groups as potential growth segments. The company will look to leverage its strong brand appeal and widespread distribution channels to improve its performance in this segment of the market.
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