PepsiCo: Pros and cons of being a food company

The food and beverage company has the ability to test and roll out products designed to appeal to local tastes and at low prices.

By Trefis Jun 20, 2012 10:29AM
TrefisPepsiCo (PEP), in partnership with Strauss Group, recently launched Obela spreads and dips in Mexico. In India, the company plans to launch 50 new products under the Frito-Lay brand to cash in on the growing demand for salted snacks. Earlier in the year, PepsiCo partnered with Germany's Theo Muller Gmbh to soon launch dairy products in the U.S.

There is a clear emphasis by PepsiCo on food products and its portfolio comprises more food products than ever before. We explore the advantages and disadvantages of a portfolio with more focus on food rather than beverages.

We maintain a price estimate of $69 for PepsiCo, which is in line with the current market price.

Advantage: Strong demand and less regulation

Food and snack products are less likely to fall prey to harsh regulations compared to carbonated soft drinks (CSDs) that are easier targets for rising obesity rates. The recent proposal by Michael Bloomberg, the mayor of New York, to put a cap on the size of soft drinks served at restaurants is just one example.

Countries worldwide are taking steps, such as increasing taxation, to discourage soft drink consumption. The consumers too are getting more health conscious and are more inclined to try out healthier products. This is evidenced from the declining trend in soft drink consumption in the U.S. for the past seven years, according to Beverage Digest.

Pepsico US CSD Market Size

Food products, on the other hand, enjoy a more favorable perception and are not viewed as completely unhealthy. With the acquisition of different companies over a period of time, PepsiCo has food products catering to different needs and tastes. Quaker Oats and the Russian dairy company Wimm-Bill-Dann (both owned by PepsiCo) are examples of products that are not considered unhealthy. Another advantage of having a wide portfolio of food products is that they are less likely to cannibalize each others' sales. For example, in general, consumers will not prefer Doritos in lieu of Quakers.

Even in developing markets, where PepsiCo is pushing heavily, consumers are more likely to spend on food rather on beverages as food offers more value for money and satiates hunger. We expect the international market size for salted snacks to rise to around $40 billion by the end of Trefis forecast period.

As long as PepsiCo is able to come out with products at a low entry price, there will be a market. And, given the huge economies of scale and extensive distribution networks, only a select few companies such as PepsiCo have the ability to test and roll out products designed to appeal to local tastes and that are affordable at the same time.

The disadvantage: Lower margins

The raw materials cost generally constitutes a lower percentage to overall costs in case of soft drinks. This means the margins are higher for soft drink products compared to food and snack products. A quick comparison between Coca-Cola's and Pepsi's margins underlines this fact.

PepsiCo Pepsi Gross Profit Margin

Coca-Cola (KO) primarily operates in beverages whereas PepsiCo has presence in beverages, snacks and even dairy. Both of the companies have a significant presence around the world and enjoy huge economies of scale. However, due to different product mix, there is a huge difference in their margins.

Another comparison can be made between H.J.Heinz Co (HNZ) and Dr Pepper Snapple (DPS). Heinz is a food and snacks company while Dr Pepper Snapple is a non-alcoholic beverage company operating in the North American region with a greater focus on soft drinks. For 2011, Heinz reported cost of goods sold as almost 65% of the revenue. For the latter, the corresponding figure was close to 43%.

Additionally, the lower fraction of costs for raw materials has another advantage. The companies are relatively unfazed by the rise in commodity prices and do not have to necessarily resort to raising product prices. To emphasize this point, a 10% increase in the cost of raw materials would eat up 6.5 percentage points from Heinz's margins whereas, in case of Dr Pepper Snapple, only 4.3 percentage points would be eroded (that is, assuming there is no change in retail price). Thus, higher margins aside, the lower cost of raw materials gives the company the ability to withstand the volatility in commodity prices.

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