Pepsi's fair value driven by snack business
Given its brand name, marketing muscle and distribution network, the soft drink and snack maker has maintained healthy margins even with low pricing.
What many investors will find surprising is that Frito-Lay's contribution to the overall stock price is almost half of the value, while the soft drink segments make up a far smaller percentage, according to our analysis.
PepsiCo competes with leading food and beverage companies around the world, including Kraft Foods (KFT), Coca Cola Co. (KO) and Dr Pepper Snapple (DPS).
Frito-Lay will introduce its corn-based snacks, which the company sells under the brand name Doritos, in India. The company is pumping in more than $100 million to build a plant there that will see the total manufacturing capacity in the country rise by about 15%. The move will help Frito-Lay extend its line of offerings, which currently include Lays chips and products from locally acquired Kurkure, among others. Pricing is a major issue in India, and companies often find themselves surviving on thin margins to drive up volumes.
Given its brand name, marketing muscle and the distribution network, PepsiCo is one of the few companies that can maintain healthy margins even with low pricing. Also, adding products to the portfolio will be less burdensome financially, as the company can use its existing supply chain and distribution networks.
After acquiring Brazil's Grupo Mabel last year, Pepsi is looking to buy Marilan, the country's fourth largest cookie maker. These two acquisitions would represent almost $1 billion of investments in a country that is the second largest cookie and cracker producer in the world. The international salted snacks market is currently worth $37 billion and will rise to $40 billion by the end of 2015.
PepsiCo has stepped up efforts to boost weak sales of its soft drink in the U.S. The company is focusing on increased marketing of Pepsi, Diet Pepsi and 7Up. The latest Diet Pepsi commercial features actress Sofia Vergara to widen its appeal to mainstream public and not just health-conscious consumers. The company's namesake brand Pepsi is spending millions on commercials during the Superbowl this year. This marketing push extends to developing countries as well. In India, PepsiCo is revamping the image of 7Up by giving it a new logo and packaging, and will soon come up with a commercial featuring a Bollywood star. According to recent reports, the company plans to spend $400 million on marketing alone this year.
Even with the increased marketing push, however, it will take some time before results begin to show. Unforeseen events -- like the recent lawsuit against PepsiCo, claiming that a dead mouse came out of a Mountain Dew can -- can adversely affect sales, albeit, temporarily.
There have also been reports that PepsiCo might consider splitting into two divisions -- one for snacks and another for beverages -- but the company has quashed such rumors. Instead, it plans to cut jobs to improve efficiency and reduce costs.
PepsiCo is under pressure to increase margins as costs soared last year and beverage sales in North America remained more or less the same.
We maintain a price estimate of $71, which is about 10% above the current market price.
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The company is scrambling to protect its equities arm, which could face declining volume and revenue as competitors close the gap.
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