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PepsiCo, Inc.

(NYSE: PEP)
Price Target: $74.00
Recommendation: BUY

Fund:

Fund Manager: Chris Henneforth, CFA


Analyst:

Report Date: June 1, 2010

Investment Thesis
PepsiCo is one of the largest consumer products
companies manufacturing and selling a wide range of
snacks, non-alcoholic beverages and food globally.
While growth in carbonated soft drinks (CSD) is
expected to be stagnant, PepsiCo is focusing on its
growing non-CSD business which it plans to expand
through product innovation. The acquisition of its two
largest bottlers in North America will help PepsiCo
bring these new products to market faster and more
efficiently.
The company is growing in the international market as
well. To accelerate its growth, PepsiCo is investing in
infrastructures in key emerging countries. It announced
recently that it is investing $2.5 billion in China.
PepsiCo, which dominates the snack food industry, is
one of the leading companies to focus on health and
nutrition in its product development through
innovations in healthier oils, sodium reduction, and
the addition of healthy
ingredients.

Risks
1

There is the risk of missteps in


integrating the two bottlers, the Pepsi
Bottling Group, Inc. (PBG) and
PepsiAmericas, Inc. (PAS) preventing the
company to fully realize the benefits and
cost savings expected from the acquisitions.

Currency risk increases as


PepsiCo derives a greater proportion
of its revenue from its international
operations.

PepsiCo operates in 200 countries


exposing it to political risk.
4
Increasing commodity prices will affect
PepsiCos performance since it is
dependent on agricultural commodity

Ohio State University SIM Fund

products.
Prices are
dependent on
global demand
and supply and
are sensitive to
extreme
weather
conditions.

Royce West, CFA


Lourdes R. Dudaney
Fisher College of Business
The Ohio State University
Columbus, Ohio
Dudaney.1@osu.edu, 614.354.6578
Table 1 Highlights
of Stock
Performance

Sector
Industry

Market Data
Current Price
52-week high
(05/12/2010)
52-week low
(05/29/2009)
Average Daily Volume
Market Capitalization
(MM)
Shares Outstanding
(MM)
Dividend Yield (Annual)
Financial Summary
EV/EBITDA
Book Value/Share
Total Debt (MM)
Return on Equity
Long-Term Debt (MM)

Consumer
Staples
Food and NonAlcoholic
Beverage

62.89
67.61
50.85
7,806,765
$101,424
1,612.72
2.864

12.61
13.34
21,858
41.24%
19,884

Figure 1 12-month Price


Performance Graph

PepsiCo Company Report

TABLE OF CONTENTS
COMPANY OVERVIEW
PEPSICO BUSINESS UNITS
INGREDIENTS AND OTHER SUPPLIES
CUSTOMERS
DISTRIBUTION NETWORK
COMPETITIVE ADVANTAGE

MACROECONOMIC ANALYSIS
COMMODITY PRICES
DEMOGRAPHIC TRENDS

3
3
5
5
5
6

6
9
10

CONSUMER STAPLES SECTOR

10

FOOD AND NON-ALCOHOLIC BEVERAGE INDUSTRY

13

SNACK FOOD INDUSTRY


SOFT DRINK INDUSTRY

COMPANY ANALYSIS

13
14

15

FUNDAMENTAL DRIVERS
FINANCIAL ANALYSIS
LIQUIDITY
LEVERAGE

15
16
19
21

COMPANY VALUATION

22

DISCOUNTED CASH FLOW (DCF) ANALYSIS

24

RISKS

26

CONCLUSION

26

PepsiCo Company Report

List of Figures
Figure 1 12-month Price Performance Graph

Figure 2 Net Revenue and Operating Income Breakdown

Figure 3 Macroeconomic Factors Relevant to PepsiCo

Figure 4 Commodity Prices

Figure 5 Snack Food Industry Product Segmentation


Figure 6 Product and Market Segmentation

14

15

List of Tables
Table 1 Highlights of Stock Performance

Table 2 Consumer Price Index: Food

Table 3 US Population Statistics by Age

10

Table 4 Consumer Staples Sector Industries and Companies


Table 5 S&P 500 Sector Performance
Table 6 Dividend Yield by Sector

12

12

Table 7 Consumer Staples Valuation

13

Table 8 PepsiCo Proforma Income Statement


Table 9 PepsiCo Profitability Ratios

18

Table 10 PepsiCo Earnings Per Share

18

Table 11 Coca-Cola Profitability Ratios

18

Table 12 Coca-Cola Earnings Per Share

19

Table 14 Comparative Profitability Ratios

19

Table 13 Comparative EPS 2009

19

Table 15 PepsiCo Liquidity Ratios

20

Table 16 Comparative Liquidity Ratios FY 2009


Table 17 PepsiCo Leverage Ratios

11

17

20

21

Table 18 Comparative Leverage Ratios FY 2009

21

Table 19 Target Price Based on Valuation Multiples

22

Table 21 PepsiCo Valuation Relative to the Soft Drink Industry


Table 20 PepsiCo Valuation Relative to S&P 500
Table 22 Comparative Company Valuations

22

22

23

Table 23 PepsiCo Discounted Cash Flow Model

25

PepsiCo Company Report

Company Overview
PepsiCo Inc. is a leading global food, snack and beverage company. The company manufactures
and sells a variety of oat, rice and grain-based snacks, carbonated and non-carbonated beverages
and food products in over 200 countries. Its largest operations are in North America (United
1
States, Canada and Mexico) and the United Kingdom.

PepsiCo Business Units


PepsiCo is organized into three business units as follows:
1

PepsiCo Americas Foods (PAF) which includes Frito-Lay North America (FLNA),
Quaker Foods North America (QFNA) and all PepsiCo Latin American food and snack
businesses (LAF).

PepsiCo Americas Beverages (PAB), which includes PepsiCo Beverages North America
and all Latin America PepsiCo beverage businesses

PepsiCo International (PI), which includes all PepsiCo businesses in Europe and all
PepsiCo businesses in Asia, Middle East and Africa (AMEA).

The six divisions under these business units are described in more detail below.
Frito-Lay North America (FLNA)
FLNA manufactures and sells branded snack foods including Lays and Ruffles potato chips,
Doritos and Tostitos tortilla chips, Cheetos cheese flavored snacks, Quaker Chewy granola bars
and SunChips multigrain snacks. FLNAs net revenue was $13.2 billion in 2009, the largest in
the company, representing 31% of the companys total revenue for that year.
Quaker Foods North America (QFNA)
QFNA manufactures and sells cereals, rice, pasta and other branded products which includes
Quaker oatmeal, Aunt Jemima mixes and syrups, Cap n Crunch cereal, Rice-A-Roni, Pasta
Roni and Near East side dishes. QFNAs net revenue was $1.9 billion in 2009, the smallest in
the company, representing 4% of the companys total revenue for that year.
Latin America Foods (LAF)
LAF manufactures and sells snack food brands including Gamesa, Doritos, Cheetos, Ruffles,
Lays, Sabritas and Quaker brand cereals and snacks. LAFs net revenue was $5.7 billion in
2009 representing 13% of the companys revenue for that year.
PepsiCo Americas Beverages (PAB)
PAB manufactures and sells beverage concentrates, fountain syrups and finished goods under a
variety of well-known brands including Pepsi, Mountain Dew, Gatorade, 7UP, Tropicana Pure
1

Source: PepsiCo Inc. 10-K Fiscal 2009


3

PepsiCo Company Report

Premium, Sierra Mist, Propel, Manzanita Sol, Tropicana juice drinks, SoBe Lifewater, Dole and
Amp Energy. PAB also manufactures and sells ready-to-drink tea, coffee and water products
through joint ventures with Unilever under the Lipton brand and Starbucks. It licenses the
Aquafina water brand to its bottlers and markets the brand. PABs net revenue was $10.1
billion in 2009 representing 23% of the companys revenue for that year.
Europe
Europe manufactures and sells both PepsiCo brand snack foods including Lays, Walkers,
Doritos, Cheetos and Ruffles, and its beverage brands including Pepsi, 7UP and Tropicana.
Similar to the PAB arrangements, Europe licenses the Aquafina water brand to its authorized
bottlers and manufactures and sells Lipton brand ready-to-drink tea. Europes net revenue was
$ 6.7 billion in 2009 representing 16% of the companys total net revenue.
Asia, Middle East & Africa (AMEA)
AMEA manufactures and sells various PepsiCo snack food brands including its international
brands such as Lays, Doritos, Cheetos and Ruffles, regional brands such as Kurkure, Chipsy,
Smiths, Red Rock Deli, many of the Quaker-brand cereals and snacks as well as beverage
concentrates, fountain syrups and finished goods, under its various beverage brands such as
Pepsi, Mirinda, 7UP and Mountain Dew. Aquafina water brand is licensed for manufacturing to
authorized bottlers and manufactures and sells Lipton ready-to-drink tea. AMEAs net revenue
was $ 5.6 billion in 2009 representing 13% of the companys total net revenue.
Net
Revenu
e by
Net Revenue by Segment
Busines
s Unit

AMEA 13%
16%

2
9
%

PepsiCo

FLNA Europe 31%

PAB
23%
QFNA 4%

AMEA 8%

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PepsiCo
Americas
Foods

Europe
PAB 25%

1
1

A
F

38% 19
%

QFNA 7%

Americas
PepsiCo

F
o
o
d

PepsicCo
Americas
Beverage
s
(PAB)
25%

56%

F
i

PepsiCo Company Report

Ingredients and Other Supplies


The principal ingredients for its food and beverage businesses are juices like apple and pineapple
juices, aspartame, corn, corn sweeteners, flavorings, flour, grapefruits and other juices, oats,
oranges, potatoes, rice seasonings, sucralose, sugar, vegetable and essential oils and wheat. The
key packaging materials include plastic resins including polyethylene terephthalate (PET) and
polypropylene resins used for plastic beverage bottles and film packaging used for snack foods,
aluminum used for cans, glass bottles and cardboard. Fuel and natural gas are important
commodities since these are used in the plants and in the trucks delivering products. These
ingredients, raw materials and commodities are purchased mainly in the open market. To reduce
the impact of volatility in raw materials and energy costs, PepsiCo uses hedging strategies, fixedprice purchase orders and pricing agreements.

Customers
PepsiCo customers include authorized bottlers and independent distributors such as food
service distributors and retailers. Bottlers have exclusive contracts to manufacture and sell
certain beverage products within a specific geographic area.
PepsiCo, Inc. completed its $ 7.8 billion acquisition of its two largest bottlers in North America,
Pepsi Bottling Group Inc. (PBG) and PepsiAmericas, Inc. (PAS) on February 26, 2010 giving
PepsiCo 80% of the volume in North America. The bottler acquisitions will provide PepsiCo the
flexibility to decide how its beverages are distributed as consumer tastes shifts from carbonated
soft drinks into noncarbonated beverages such as water, juices and teas. PepsiCo expects the
transactions to create pre-tax cost savings of about $125 to $ 150 million starting 2010 and
approximately $400 million annually starting 2012. The initial synergies are due primarily due to
greater cost efficiencies but expect synergies due to a combination of cost savings and new
revenue-generating opportunities in later years.
Retail consolidation and the economic environment have increased the power of major retailers
such as Wal-Mart which represented 13% of its total net revenue in fiscal 2009.

Distribution Network
PepsiCo products are brought to market through the following channels:
1

Direct-Store-Delivery (DSD) Bottlers and distributors operate DSD systems that


directly deliver snacks and beverages to the retail stores. DSD enables PepsiCo to display
its merchandize to maximize its visibility and appeal. This distribution method is ideal for
products that are restocked often and promoted in-store

Customer Warehouse PepsiCo delivers products to customer warehouses and retail


stores. These is a less expensive system that work best for products that are not fragile,
have longer shelf life, lower turnover and less likely to be an impulse purchase.

Foodservice and Vending PepsiCo sales force distribute snacks, food and beverages to
third-party foodservice and vending distributors and operators. This is the distribution
5

PepsiCo Company Report

network that supplies products to restaurants, businesses, schools, stadiums and


similar locations.

Competitive Advantage
PepsiCo owns a broad portfolio of globally recognizable brand name products with 19 product
lines generating at least $1 billion in sales. It has global reach in that it operates in 200 countries.
It is best known for its lines of carbonated soft drinks (CSD) which has been part of the
American culture for a long time. In addition, its syrup recipes used to manufacture drinks is a
secret and protected by trademark. Manufacturers pay for licenses to PepsiCo to manufacture
and sell beverages over a specific geographical area. The company has a well established
distribution channel. Operating in the soft drink industry requires a high level of capital
investment such that producers like PepsiCo which is already established in the market can
benefit from economies of scale.
In addition to its beverage portfolio, PepsiCo has a strong portfolio of snack and food products.
The company benefits from the coincidence of consumption between snacks and beverages. Its
FLNA division dominates the snack industry with 51% market share in the snack industry.

Macroeconomic Analysis
The US economy, in terms of real GDP, is expected to grow by 3.0 % in 2010 compared to a
contraction of 2.9% in 2009. However, unemployment is expected to remain high at above 9%
through the end of this year and higher than 8% by the end of 2011. This will keep consumers
cautious with consumer spending expected to increase by 4.5% from the 2009 lows.

Fears that the European debt crisis will slow down the global recovery spread in May. The
governments of Greece, Portugal, Spain, Italy and Ireland have to cut government spending to
rein in their deficits which meant stifling consumer spending in the region. As a result, the euro
declined against the US dollar to a four year low of $1.2178 on May 26. For US multinationals
with significant operations in the EU countries, this means a decrease in revenue when translated
in dollar terms. Europe represents 16% of PepsiCos net revenue in 2009 with the United
Kingdom as its largest market.

PepsiCo Company Report

Figure 3 Macroeconomic Factors Relevant to


PepsiCo

PepsiCo Company Report

Although real disposable income is expected to rise by 1.4% together with other income
categories in 2010, continued high unemployment, the effect of sovereign debt crisis in Europe
to the global recovery and other economic issues will continue to weigh in the American
consumers minds suggesting continued restraint in spending. Consumers will continue to
focus on value when making purchasing decisions putting pressure on manufacturer and retailer
margins and may mean trading down or staying with store brands.
Consumer spending for food is estimated to increase by 2.8% but this will be due to increased
prices. In 2010, the Consumer Price Index (CPI) for all food is projected to increase 2.5 to 3.5
percent, both food-at-home (grocery store) and food-away-from-home (restaurant) prices are
expected to increase within the same percentage range. The all-food CPI increased 1.8 percent
between 2008 and 2009. Food-at-home prices increased by 0.5 percent, the lowest annual
increase since 1967 while food-away-from-home prices rose 3.5 percent in 2009. Non-alcoholic
beverage prices are forecasted to rise by 2.5% to 3.5% in 2010.

Table 2 Consumer Price Index: Food

Source: Bureau of Labor Statistics. Forecasts by Economic Research Service


8

PepsiCo Company Report

Commodity Prices
Agricultural commodity prices are expected to flatten. Agricultural commodity prices declined
starting in the middle of 2008 reflecting the decreasing speculation that commodity prices will
keep on rising. Foreign demand was also helped by strengthening of overseas currencies
relative to the US dollar providing foreign buyers more purchasing power. However, this trend
has reversed with the dollar strengthening against the euro and the British pounds. Due to this
rising strength of the US dollar crude oil prices have been declining as well. The EU debt crises
might keep the dollars strong in the next few months.

Figure 4 Commodity Prices

PepsiCo Company Report

Demographic Trends
Baby boomers refer to Americans born in the post-World War II era, between 1946 and 1964,
with the the oldest of the boomers will turn 65 years of age by 2011. According to U.S. Census
Bureau projections, by 2030 there will be 72 million Americans over age 65 representing more
3

than 19% of the US population . With the aging US population, rising life expectancy and rising
healthcare costs, Americans are paying more attention to nutrition. Companies like PepsiCo are
targeting the growing baby boomer population. PepsiCo is expanding its good for you
product portfolio focusing on wellness and nutrition with plans to cut sodium, saturated fat and
sugar in the next five years.
Table 3 US Population Statistics by Age
Year 2010 Year 2030
Percent of
Age

0-14
15-64
65-99
Total

Population

Population

62,380,610
207,623,54
1
40,228,712
310,232,86
3

20%
67%
13%
100%

Percent of
Age

0-14
15-64
65-99
Total

Population

72,959,056
228,452,70
3
72,091,915
373,503,67
4

Population

19.5%
61.2%
19.3%
100%

known
branded
products.
The US Census Bureaus
It is
international database shows
divided
that world population will
into five
increase 20% by 2030. Only
industries:
2.5% of this growth will come
the food
from more developed countries
with less developed countries and staples
retailing,
growing 40 times faster than
beverage,
developed ones. Companies
food
which are positioned to
compete in the less developed products,
tobacco,
regions could see substantial
household
growth.
products
Consumer Staples Sector and
personal
The consumer staples sector is a products
defensive sector consisting of industries.
established companies with well The

industries 2.54% and 2.43% weight in the


are further S&P 500, respectively, while the
divided
smallest is the brewers with
into twelve 0.066% weight in the S&P 500.
subWal-Mart has both the largest
industries. market capitalization and annual
The sector revenue in the sector with $189
represents billion market capitalization and
11.31% of annual revenues of $408 billion.
the S&P Table 4 below shows the
500 index. industries and companies within
Household the sector and their market
products capitalization and latest annual
and the
revenue data.
soft drink
subindustries
are the
largest in
the sector 3
Source: U.S. Census Bureau,
with
International Data Base.
10

PepsiCo Company Report


Table 4 Consumer Staples Sector Industries and Companies

Industry
Group

SubIndustry

Industry

Food & Staples Retailing Food & Staples Retailing Drug Retail
Food Distributors
Food Retail

Market
Capitalizat
ion
CVS Caremark Corp
$47,127.4
Walgreen Co
$31,348.9
Sysco Corp
$17,635.2
Kroger Co/The
$13,008.4
Safeway Inc
$8,603.6
SUPERVALU Inc
$2,858.7
Whole Foods Market
Inc
$6,931.7
Companies

Annual
Revenu
e
$98,729.0
$63,335.0
$36,853.3
$76,733.0
$40,850.7
$40,597.0
$8,031.6

Hypermarkets & Super Centers Costco Wholesale

Corp

Food, Beverage & Tobacco Beverages

Brewers
Distillers & Vintners

Soft Drinks

Food Products

Agricultural Products
Packaged Foods & Meats

Tobacco

Household & Personal


Products

Tobacco

Household Products Household Products

$25,659.5 $71,422.0
Wal-Mart Stores Inc $189,658.6$408,214.0
Molson Coors
Brewing Co
$7,609.1 $3,032.4
Brown-Forman Corp
$8,223.8 $2,481.0
Constellation Brands
Inc
$3,550.8 $3,364.8
Coca-Cola Co/The
$118,582.4 $30,990.0
Coca-Cola
Enterprises Inc
$13,061.1 $21,645.0
Dr Pepper Snapple
Group Inc
$9,301.8 $5,531.0
PepsiCo Inc/NC
$101,423.9 $43,232.0
Archer-DanielsMidland Co
$16,249.9 $69,207.0
Campbell Soup Co
$12,185.0 $7,586.0
ConAgra Foods Inc
$10,773.6 $12,731.2
Dean Foods Co
$1,933.1 $11,158.4
General Mills Inc
$23,632.5 $14,691.3
Hershey Co/The
$10,634.6 $5,298.7
HJ Heinz Co
$13,971.3 $10,495.0
Hormel Foods Corp
$5,319.2 $6,533.7
JM Smucker Co/The
$6,578.0 $3,757.9
Kellogg Co
$20,338.4 $12,575.0
Kraft Foods Inc
$49,863.6 $40,386.0
McCormick & Co
Inc/MD
$5,108.1 $3,192.1
Mead Johnson
Nutrition Co
$10,086.9 $2,826.5
Sara Lee Corp
$9,370.2 $12,881.0
Tyson Foods Inc
$6,627.1 $26,704.0
Altria Group Inc
$42,255.3 $16,824.0
Lorillard Inc
$10,927.6 $3,686.0
Philip Morris
International Inc
$81,704.8 $25,035.0
Reynolds American
Inc
$15,196.3 $8,419.0
Clorox Co
Colgate-Palmolive
Co
Kimberly-Clark Corp
Procter & Gamble
Co/The

$8,847.7

$5,450.0

$38,229.5 $15,327.0
$25,128.1 $19,115.0
$175,933.3 $79,029.0

Personal Products

Personal Products

Avon Products Inc


Estee Lauder Cos Inc

$11,348.4 $10,382.8
$11,620.8 $7,323.8

11

PepsiCo Company Report

As a defensive sector, consumer staples performance is less sensitive to economic downturns


relative to other sectors. The consumer staples sector outperformed the S&P 500 over the last
two and three year periods ending in April 2010 which included the recent downturn. It lost
2.23% and gained 0.82% over the last two and three years, respectively, compared to a loss of
14.35% and 19.95% for the S&P 500 for the same periods, respectively. During 2010 when the
economy showed clear signs of recovery, it underperformed the S&P 500. The sector return was
4.71% versus 10.51% for the S&P 500 in the first quarter and a return of -1.56% versus 1.48%
for the S&P 500 for the month of April.

Table 5 S&P 500 Sector Performance

The consumer sector is in the mature stage of the lifecycle such that all the companies in the
sector pay out regular quarterly dividends. It currently has a dividend yield of 3.03%
Table 6 Dividend Yield by Sector
Sector
Energy
Materials
Industrials
Consumer Discretionary
Consumer Staples
Health Care
Financials
Information Technology
Telecommunication Services
Utilities

Dividend Yield
%

2.36
1.9
2.22
1.42
3.03
2.07
1.14
0.94
6.17
4.62

Source: Standard and Poors


1
2

PepsiCo Company Report

In terms of valuation multiples, the consumer staples sector multiples are undervalued relative to
their absolute historical multiples with current levels below their 22-year historical medians.
Similarly, the sectors current valuation multiples relative to the S&P 500 is below its historical
medians versus the index.
Table 7 Consumer Staples Valuation
Consumer Staples
Valuation Relative
Consumer Staples Absolute Valuation
to S&P 500
Valuation
Ratios

High

Low

Median Current

P/Trailing
EPS

34.8

12.2

20

15.6

P/Forward
EPS

35.2

12.1

18.2

14.6

P/B
P/S
P/CF

8.4
2.1
22.5

2.6
0.6
8.6

5.3
1.2
13.8

3.4
0.8
11.6

Valuation
Ratios

High

Low

Median Current

P/Trailing EPS

1.5

0.74

1.1

0.84

P/Forward EPS

1.6

0.76

1.1

0.94

P/B
P/S
P/CF

2.7
1.2
1.5

0.8
0.5
0.7

1.7
0.8
1.2

1.5
0.6
1.1

such as sugar
Food and Non-Alcoholic and
confectionar
Beverage Industry
y, fruit and
PepsiCo is classified under
vegetable
the soft drink industry.
preserving
However, unlike its
which
competitors in the soft drink
includes
industry, it is not a pure play frozen food
soft drink company. It has a
manufacturin
large portfolio of snacks and
g, fruit and
food products.
vegetable
canning,
In 2009, retail sales from
dairy
food and beverage stores
products
totaled an estimated $575.8
manufacturin
billion, up by 0.38% from
g to name a
the previous year based on
few.
estimates by the US
Discussion
Department of Commerce.
in this paper
Consumers spent an
will be
additional $459.5 billion at
limited to the
food services and drinking
snack food
places such as restaurants,
industry
up 0.29% from 2008.
since
The food industry is comprised PepsiCo has
of a wide variety of categories a dominant

position in Industry
that industry
The snack food industry is
through its
estimated to generate $25.8
FLNA
billion in revenue. Frito Lay
division.
dominates the industry with
PepsiCo is a an estimated 51% of the
key player in market. The other key players
the cereal
have single digit share of the
industry.
market with ConAgra Foods a
However, it distant second with 6%
only has an market share.
8% share
through its Industry performance is
Quaker Foodsinfluenced by agricultural
division. The commodity prices such as
industry is nuts, corn, sugar and grains. It
dominated by competes with products such
Kellogg with as cereals and confectionery.
34.2% market Like the beverage industry,
consumers increased health
share and
consciousness affects the
General Mills
demand for its products.
with 31.2%
market
share.

Snack
Food
13

Source: IBISWorld Industry Report


31191 Snack Food Production in
the US

PepsiCo Company Report

Figure 5 Snack Food Industry Product Segmentation

The most popular snack food are chips whether potato, corn or other chips with 71.5% of the
market. The nuts and seeds segment is a distant second with 11.5% market share.
Companies in this industry have to continuously innovate and introduce new products to
stimulate sales. PepsiCo introduced a baked line of potato chips a few years ago and recently
added a kettle-cooked reduced fat chips line.
Snack foods are sold primarily through grocery wholesalers which account for 83.4% of the
market in 2009. These wholesalers sell to supermarkets and convenience stores.
Manufacturer sales directly to retailers account for only 13.4% of the market. However, this
segment is expected to increase since large retailers such as Wal-Mart can realize huge cost
savings from bypassing wholesalers and negotiating directly with the manufacturers.

Soft Drink Industry


The non-alcoholic beverage industry is dominated by carbonated soft drinks (CSDs) with
54.3% of industry revenue. However, the categorys share of industry revenue has been falling
due to the shift in consumer preference to non-carbonated beverages. According to Beverage
Digest, the CSD category in the US last grew in 2004. Major industry players have turned their
focus to producing and marketing non-carbonated drinks. Another trend within the carbonated
soft drink segment is the slowing growth of diet CSDs which started in 2005.
Bottled water includes flavored waters which at times are enhanced with vitamins. The category
is estimated to account for 14.5% of the industrys production in 2008. During the economic
downturn, growth in the category slowed down as more consumers turned to tap water. This is a
competitive category due to the commodity nature of the product, resulting in lower prices
compared to other beverages.
1
4

PepsiCo Company Report

The sports drinks, energy drinks and juice categories are viewed to have the greatest growth
potential since these provide consumers with additional benefits such as nourishment from
juices, faster hydration from sports drinks and increased alertness from energy drinks. Sports
6
drinks account for 8.4% of industry revenue with Gatorade as the leading brand in the category.
The energy drink segment which represents 14.4% of sales by the industry is dominated by Red
Bull. Other beverages include tea and soy-based drinks.

Product Segmentation
Other
Ice 3.30%
1.50%

Sports drinks
8.40%

Fruit beverages
14.40%

Energy drinks
3.60%

Bottled water
14.50%

Carbonated soft
drink
54.30%

Vending
machine
operators
11%

Other
8%

Convenience
stores and
gas
stations
12%

Market Segmentation

Food service
and drinking

Expor
t
1%

Supermarkets
and general
merchandisers
48%

places
20%

Total $ 44.4 bn

Figure 6 Product and Market Segmentation

Supermarkets and general merchandisers is the largest market for the sale of soft drinks and
bottled water and is the major channel to reach the end consumers. This is followed by food
service and drinking places, which includes fast food, takeout restaurants, diners, full-service
restaurants and bars. During the economic downturn, consumers cut down on dining out
resulting in a decline in sales to this segment.
Coca-Cola has the largest share of the soft drink market with 35% market share and a market
capitalization of $118.582 billion. It is followed by PepsiCo with a market share of 27% and
a market capitalization of $101.424 billion. A distant third is Dr. Pepper Snapple Group with
a market share of 6.5% and a market capitalization of $9.302 billion.

Company Analysis
Fundamental Drivers
PepsiCo intends to expand its macro snack business by growing its business outside the US and
developing and introducing new products based on changing consumer tastes and catering to
local tastes.
The company announced recently that it will invest $2.5 billion in China in addition to the $1
billion it had committed in 2008. The investment will be used to build new manufacturing
facilities, increase research and development, increased agricultural development and building
its brands in the country. PepsiCo plans to open 10-12 new plants in China to manufacture soft
drinks, non-carbonated beverages and snacks and expand production lines in existing facilities.
In addition, it plans to build a research and development center in China to develop products for
6

Source: IBISWorld Industry Report 31211 Soft Drink Production in the US

15

PepsiCo Company Report

all of Asia and broaden its portfolio to provide more food and beverage choices using
wholesome ingredients.
Due to heightened health awareness, and increasing obesity concerns, Americans are turning
away from snack foods high in fat and sodium. PepsiCo has responded to this trend by
expanding its portfolio of healthier snack foods. It has eliminated trans-fat from its chips
snacks by using corn oil and added a line of baked chips. It announced earlier this year that it is
developing a new designer salt that will reduce sodium in its potato chips products by 25% or
more without impact on taste. In 2008, Frito-Lay introduced a line of premium nuts through its
TrueNorth line as another option to health-conscious consumers. By rolling out new innovative
products and differentiating its brands, PepsiCo can shift the buying habits of price conscious
consumers to purchase its premium brands over store brands.
PepsiCo acquired its two largest bottlers in North America to grow its beverage business. In the
past few years Pepsi have launched and acquired a range of non-carbonated brands as demands
for carbonated beverages declined and consumers shifted its preference to sports drinks, energy
drinks, water, juices and tea. Smaller brands such as fortified water, juices, and energy drinks
which are sold at relatively low volumes, do not have the economies of scale that bottlers found
attractive to distribute since the industrys operating margins are low. The acquisitions provide
PepsiCo the flexibility in getting its products to market faster and more efficiently. In addition,
large retail store chains such as Wal-Mart and Kroger have been demanding customized route to
market. By vertically integrating, PepsiCo eliminates any profitability conflicts that can exist
between two companies. It then enables PepsiCo to be more responsive to the demands of both
retailers and end consumers.
The buying power of retailers has increased over the past decade due to the consolidation in the
industry. With its extensive portfolio of snacks, food and beverage products PepsiCo increases
its bargaining power over the retailers in terms of pricing and shelf space. PepsiCo has the first
mover advantage in the industry shift to vertically integrate the bottlers and had started realizing
the synergies of the combined companies. Coca Cola is yet to close on its acquisition of Coca
Cola Enterprises which is expected in the Fall of 2010.

PepsiCos plans to expand its good for you portfolio which currently generates $10 billion in
revenue from its core products led by Tropicana, Lebedyansky, Pandora in the juice brands,
Aquafina, Quaker for grains, G, Gatorade for athletes and the new dairy joint venture with
Almarai. PepsiCo intends to expand this to a $30 billion dollar portfolio by investing in R&D to
find science-based innovations and through targeted acquisitions and joint ventures.

Financial Analysis
PepsiCo revenue is estimated to increase between eight to nine percent driven by growth in its
snack food business and regional growth in its emerging markets segment, AMEA. Prior to the
7

Morningstar Stock Strategist Industry Reports Coke Rises to the Pepsi Challenge by Philip Gorham, CFA, April
14, 2010
1
6

PepsiCo Company Report

economic downturn PepsiCo revenue was growing at an average of 9% year over year for the six
years prior to the recent recession. The sharp increase in revenue between fiscal year 2009 and
2010 in the proforma income statement shown in Table 8 is due to revenues from the two
bottlers acquired in February which are now going to be reflected in PepsiCos consolidated
financial statements. Operating income improvements of around 6% year over year is expected
as PepsiCo continues its cost management initiatives and improves efficiency. Operating margin
is 18% consistent with the companys experience.
Table 8 PepsiCo Proforma Income Statement
FY

FY

FY

2012E
67,100

2011E
61,260

2010E
56,661

2009
43,232

2008
43,251

2007
39,474

2006
35,137

2005
32,562

Operating Expenses

55,108

50,164

46,111

35,188

36,292

32,292

28,635

26,578

Operating Income

11,992

11,096

10,549

8,044

6,959

7,182

6,502

5,984

365

374

560

553

495

(805)
121

(735)
110

(680)
102

(397)
67

(329)
41

(224)
125

(239)
173

(256)
159

(684)

(625)

(578)

35

86

461

487

398

11,307

10,471

9,971

8,079

7,045

7,643

6,989

6,382

3,392

3,141

2,792

2,100

1,879

1,973

1,347

2,304

7,915

7,329

7,179

5,979

5,166

5,670

5,642

4,078

(Millions)

Net Sales

FY

FY

FY

FY

FY

Interest expense and Income

Bottling Equity Income


Interest Expense
Interest Income
Total
Inc before inc taxes & minority interest
Provision for Income taxes
Net Income
Less: Net Income attributable to noncontrolling interest

(33)

(24)

(12)

Net Income

7,915

7,329

7,179

5,946

5,142

5,658

5,642

4,078

Common Shares

1,453

1,553

1,653

1,584

1,568

1,618

1,642

1,659

5.45
-

4.72
-

4.34
-

3.81
-

3.26
-

3.48
-

3.42
-

2.43
-

5.45

4.72

4.34

3.81

3.26

3.48

3.42

2.43

1,453

1,553

1,653

1,584

1,597

1,639

1,681

1,700

5.45
-

4.72
-

4.34
-

3.71
-

3.21
-

3.41
-

3.34
-

2.39
-

5.45

4.72

4.34

3.71

3.21

3.41

3.34

2.39

EPS-Basic (pre acct chnge)


Cumul effect of acct change
Net Income
Diluted Shares

EPS-diluted
Cumul effect of acct change
Net Income

Profitability
PepsiCo has been consistently profitable with profit margins consistently above 10% in this
decade and a return of over 30% to its common equity holders for most the decade.

1
7

PepsiCo Company Report


Table 9 PepsiCo Profitability Ratios
FY 2009

FY 2008

FY 2007

FY 2006

FY 2005

FY 2004

FY 2003

FY 2002

FY 2001

FY 2000

Gross Margin
Operating Margin
Pretax Margin
Profit Margin
Return on Assets
Return on Common
Equity
Return on Capital

53.51
18.61
18.69
13.75
15.67

52.95
16.03
16.23
11.89
14.56

54.30
18.16
19.33
14.33
17.52

55.14
18.52
19.89
16.06
18.27

56.46
18.19
19.60
12.52
13.65

54.18
18.49
18.95
14.39
15.79

54.10
18.49
18.51
13.23
14.61

54.22
18.00
17.65
11.95
13.27

54.28
18.75
17.14
11.32
12.52

61.14
15.78
15.71
10.68
11.40

41.24
27.49

35.14
25.45

34.78
29.01

38.13
31.00

29.43
23.29

33.25
27.86

33.45
27.87

33.05
26.06

32.71
24.93

30.14
22.48

Effective Tax Rate

25.99

26.76

25.86

19.27

36.10

24.74

28.53

32.33

33.93

31.99

Earnings per share (EPS) has been growing above 10% year over year during the decade
except for years during a recession. EPS long-term future growth rate is expected to be 9%.
Table 10 PepsiCo Earnings Per Share

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010 2011E

March

0.28

0.33

0.35

0.39

0.46 0.53 0.60 0.65 0.70 0.71 0.76 0.84

June

0.33

0.46

0.48

0.54

0.61 0.70 0.80 0.94 1.03 1.02 1.09 1.25

September

0.42

0.49

0.52

0.58

0.66 0.78 0.88 0.99 1.06 1.08 1.24 1.34

December

0.39

0.44

0.44

0.52

0.58 0.65 0.72 0.80 0.88 0.90 1.09 1.22

Year

1.42

1.72

1.79

2.03

2.31

2.66

3.00

3.38

3.67

3.71

4.16

4.64

Year over Year

15%

21%

4%

13%

14%

15%

13%

13%

9%

1%

12%

12%

Coca-Cola margins are higher compared to PepsiCo. During the decade, its gross margin has
been above 60% and its profit margin approximately 20%. However, its return ratios are
comparable to PepsiCo.
Table 11 Coca-Cola Profitability Ratios
FY 2009

FY 2008 FY 2007 FY 2006 FY 2005 FY 2004

FY 2003 FY 2002 FY 2001 FY 2000

Gross Margin

64.22

64.39

63.99

66.12

64.33

64.70

63.12

63.68

65.55

68.81

Operating Margin

26.56

26.44

26.06

27.39

26.13

26.21

27.53

27.90

30.50

25.81

Pretax Margin

28.87

23.29

27.28

27.31

28.96

28.62

26.11

28.11

32.32

17.09

Profit Margin

22.02

18.18

20.73

21.09

21.09

22.29

20.66

15.59

22.62

10.95

Return on Assets

15.30

13.86

16.33

17.11

16.01

16.49

16.77

13.00

18.35

10.26

Return on Common Equity

30.15

27.51

30.94

30.53

30.18

32.29

33.58

26.33

38.38

23.12

Return on Capital

21.31

19.87

23.78

24.11

22.35

23.46

24.48

18.99

26.53

16.04

Effective Tax Rate

22.80

21.94

24.03

22.77

27.17

22.10

20.89

27.70

29.82

35.95

Coca-Colas EPS has been more volatile than PepsiCo during this decade with more years in
single digit growth. It experienced a negative 3% EPS growth during the latest recession in 2009.
For the same year, PepsiCos EPS was still positive at 1%. This is due to PepsiCos FLNA
and AMEA growth during the year. Long-term EPS growth is lower than PepsiCo at 8%.
1
8

PepsiCo Company Report


Table 12 Coca-Cola Earnings Per Share
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

March

0.22

0.35

0.34

0.37

0.46

0.47

0.49

0.56

0.67

0.65

0.8

0.87

June

0.42

0.45

0.49

0.57

0.65

0.68

0.74

0.85

1.01

0.92

1.02

1.12

September

0.42

0.41

0.45

0.55

0.5

0.57

0.62

0.71

0.83

0.82

0.89

0.98

0.46

0.46

0.46

0.52

0.58

0.64

0.66

0.73

0.80

December

0.38

0.37

0.38

Year

1.44

1.58

1.66

1.95

2.07

2.18

2.37

2.7

3.15

3.05

3.45

3.75

Year to Year

12%

10%

5%

17%

6%

5%

9%

14%

17%

-3%

13%

9%

Dr Pepper Snapple Group (DPS) financial data as a publicly traded company started in 2008
when it was spun off by Cadbury Schweppes. It is the smallest soft drink manufacturer in the
index. DPS profitability ratios and returns are either similar to PepsiCos or lower. Longterm estimated EPS growth is lower at 8%.
Table 14 Comparative Profitability Ratios
Table 13 Comparative EPS 2009
PepsiCo

Gross Margin

53.51

CocaCola

64.22

General
DPS
59.61

Kraft
36.15

General

Mills

DPS

35.62

Kraft

Mills*

Operating Margin

18.61

26.56

19.62

13.53

15.52

Year

1.97

2.04

3.98

Pretax Margin

18.69

28.87

15.69

10.62

13.78

Year to Year

7%

8%

10%

Profit Margin

13.75

22.02

10.03

7.48

8.88

8%

8%

9%

Return on Assets
Return on Common
Equity

15.67

15.30

6.37

4.65

7.07

L/T Growth rate


* Fiscal year 20082009

41.24

30.15

19.16

12.54

22.90

Return on Capital

27.49

21.31

11.53

8.95

12.09

Effective Tax Rate

25.99

22.80

36.29

29.37

35.58

Kraft and General Mills are included in the comparison with PepsiCo since both these companies are
PepsiCos competitors in the snack food and cereal industries. Kraft and General Mills have lower
margins and returns compared to PepsiCo and the soft drink industry in general.

Liquidity
PepsiCos liquidity position has been consistently strong as shown by several liquidity
measurement ratios. Its cash, quick and current ratios have been improving over time which
means that its ability to meet its short-term debt obligations has been strengthening. With its
current quick ratio PepsiCos more liquid current assets (cash, short-term investments and
receivables), can meet its entire current liabilities.
On the other hand, its cash conversion cycle metrics which measures the number of days that the
companys cash is tied up in inventory and sales process has been increasing. Its inventory
turnover days increased from 40 days in 2004 to 46 in the last fiscal year, its inventory to cash
days increased from 75 in 2001 to 85 in 2009 and its accounts receivable turnover days
increased from 33 days in 2001 to 39 days in the last fiscal year.

19

PepsiCo Company Report

PepsiCos working capital has been increasing over the years and stood at $3.8 billion by the end of
2009. However, its cash flow from operations as a percentage of total debt has been declining.
Table 15 PepsiCo Liquidity Ratios
FY
2009

Cash Ratio
Quick Ratio
Current Ratio
Total Debt/Total Capital
Cash & Equivalents/Current
Assets
Accounts Receivable TurnoverDays
Inventory Turnover Days
Inventory to Cash Days
CFO/Total Debt
Cashflow/Total Liabilities
Working Capital (MM)

0.4
7
1.0
0
1.4
4
31
%
33
%
39
46
85
86
%
30
%
$3,81
5

FY
2008

FY
2007

FY
2006

FY
2005

FY
2004

FY
2003

FY
2002

FY
2001

FY
2000

0.2
6
0.32 0.41 0.52 0.51 0.31 0.30 0.33 0.31
0.7
9
0.89 0.95 0.87 0.95 0.75 0.72 0.76 0.76
1.2
3
1.31 1.33 1.11 1.28 1.08 1.06 1.17 1.17
40
%
22% 16% 27% 20% 16% 22% 26% 30%
21
%
24% 31% 47% 40% 29% 29% 28% 27%
3
9
37
36
36
36
36
34
33
35
4
4
43
42
42
40
40
42
42
49
8
2
80
78
78
76
77
76
75
84
85
%
147% 215% 113% 146% 189% 168% 127% 138%
29
%
40% 42% 33% 35% 32% 33% 29% 34%
$2,01
9
$2,398 $2,270$1,048 $1,887 $515 $361 $855 $822

PepsiCo has the strongest liquidity ratios in terms of its cash, quick and current ratios compared
to its competitors. In terms of cash conversion cycle metrics, Dr Pepper Snapple has the
shortest turnover days to convert inventory to sales and inventory to cash.
Table 16 Comparative Liquidity Ratios FY 2009

PepsiC
o

Cash Ratio
Quick Ratio
Current Ratio
Total Debt/Total Capital
Cash & Equivalents/Current
Assets
Accounts Receivable TurnoverDays
Inventory Turnover Days
Inventory to Cash Days
CFO/Total Debt
Cashflow/Total Liabilities
Working Capital (MM)

Dr. Pepper
CocaCola Snapple

General
Kraft

Mills

0.47
1.00
1.44
31%

0.67
0.95
1.28
32%

0.33
0.96
1.5
48%

0.18
0.64
1.08
42%

0.21
0.47
0.98
57%

33%

52%

22%

17%

21%

39
46
85
86%
30%
$3,815

40
75
115
68%
35%
$3,830

35
43
78
29%
15%
$425

45
54
99
27%
12%
$963

26
53
79
26%
15%
-$71

2
0

PepsiCo Company Report

Leverage
Total debt is calculated by adding short-term debt to long-term debt obligations. PepsiCos
total debt is mostly composed of its long term debt starting in 2006 since leverage ratios using
long term debt and total debt were not a lot different during those years. This is confirmed by
calculating the percentage of long-term debt to total debt. Long-term debt has been over 90% of
total debt during that period. In 2005, long-term debt was only 44% of its total debt. PepsiCos
leverage ratios peaked in 2008 and showed a sharp improvement in 2009 and are now less than
half of common equity.
Table 17 PepsiCo Leverage Ratios
FY
2009

LT Debt/Common
Equity
LT Debt/Total Capital
LT Debt/Total Assets
Total Debt/Common
Equity
Total Debt/Total Equity
Total Debt/Total Capital
Total Debt/Total Assets
Total Debt/Market Cap

FY
2008

FY
2007

FY
2006

FY
2005

FY
2004

FY
2003

FY
2002

FY
2001

FY
2000

44.1% 65.1% 24.4% 16.6% 16.3% 17.8% 14.4% 23.1% 30.7% 39.6%
29.2% 38.6% 19.1% 14.0% 11.9% 14.1% 12.0% 17.8% 22.7% 27.8%
18.6% 21.8% 12.1% 8.5% 7.3% 8.6% 6.7% 9.3% 12.2% 14.5%
46.9%
45.1%
31.1%
19.7%
8.2%

68.2%
68.0%
40.5%
22.9%
9.7%

27.5%
27.4%
21.5%
13.7%
3.8%

18.4%
18.4%
15.5%
9.4%
2.8%

36.6%
36.5%
26.7%
16.4%
5.3%

25.6%
25.5%
20.3%
12.3%
4.0%

19.4%
19.3%
16.2%
9.1%
2.9%

29.0%
28.9%
22.4%
11.7%
3.8%

34.7%
34.6%
25.7%
13.9%
3.5%

42.2%
42.1%
29.6%
15.5%
3.7%

Dr Pepper Snapple and General Mills have high leverage compared to the other companies.
Coca-Colas short-term debt must be a significant part of its total debt since its leverage
using long-term debt looks much better than when total debt is used. PepsiCo and Coca-Cola,
currently, have similar leverage ratios when using total debt to calculate leverage.
Table 18 Comparative Leverage Ratios FY 2009

General
PepsiCo

CocaCola

DPS

Kraft

Mills

LT Debt/Common Equity
LT Debt/Total Capital
LT Debt/Total Assets

44.1%
29.2%
18.6%

20.4%
13.6%
10.4%

92.9% 69.7% 111.2%


48.2% 40.1% 46.1%
33.7% 27.0% 32.2%

Total Debt/Common
Equity
Total Debt/Total Equity
Total Debt/Total Capital
Total Debt/Total Assets
Total Debt/Market Cap

46.9%
45.1%
31.1%
19.7%
8.2%

47.8%
46.8%
31.9%
24.4%
9.0%

92.9%
92.9%
48.2%
33.7%
41.0%

73.4% 136.7%
73.1% 130.3%
42.2% 56.6%
28.5% 39.6%
47%
42%

2
1

PepsiCo Company Report

Company Valuation
PepsiCos current valuation ratios are lower than their 22-year medians on an absolute basis. I
used each of the ratios to calculate a target price for PepsiCo. Assuming the these multiples are
going to move towards their long-term medians, I arrived at an average and median target price
of $75 for PepsiCo.
Table 19 Target Price Based on Valuation Multiples
Valuation Ratio

High

P/Forward E
P/S
P/B
P/EBITDA

Low

Median

Current

Target
Multiple

Target
Metric
Value

Target
Price

32.5

13.1

20.7

15.1

17.8

4.16

74.05

3.6
10.6
16.79

0.9
3.3
5.49

2.2
6.7
11.91

2.4
6.1
10.23

2.2
6.4
11

34.28
11.51
7.25

75.42
73.66
79.75

24.9

8.1

16.5

13.6

14.5

5.16

74.82
75.54
74.82

P/CF

Average
Median

PepsiCo valuation is in line with the Soft Drink industry. Its current valuations are only slightly
more expensive or cheaper relative to the industry and the historical medians. In terms of
current relative valuation to the S&P 500, PepsiCo is undervalued on the basis of both price-toearnings ratios and overvalued on P/B, P/S and P/CF.
Table 21 PepsiCo Valuation Relative to the Soft Drink Industry

Valuation
Ratio

High

Low

Table 20 PepsiCo
Valuation Relative to
S&P 500

Median Current
Valuation
Ratio

P/Trailing E

1.2

0.64

0.94

0.98

P/Forward E

1.1

0.64

0.97

0.97

P/B
P/S
P/CF

1.6
1.3
1.3

0.1
0.4
0.3

0.7
0.7
1.1

1.1
1.1
1

High

Low

P/Trailing E

0.88

1.3

0.92

P/Forward E

1.4

0.85

1.2

0.97

P/B
P/S
P/CF

4.3
2.6
2

1.4
1
1

2.3
1.8
1.6

2.6
1.8
1.3
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PepsiCo Company Report

Coca-Cola Enterprises is in the process of being acquired by Coca-Cola. I included the


company in the figure below since its valuation is still reflected in the industry level valuations.
Current valuations of Dr Pepper Snapple are lower than the soft drink industry valuations.
Coca-Cola is expensive relative to PepsiCo in all measures below except trailing P/E. Kraft and
General mills have valuations comparative to PepsiCo in terms of forward P/E and P/CF and
less expensive in all other measures.
Table 22 Comparative Company Valuations

Name

Soft Drinks
Coca-Cola Co/The
Coca-Cola Enterprises Inc
Dr Pepper Snapple Group Inc
PepsiCo Inc/NC
Soft Drinks Valuation
Packaged Foods & Meats
Campbell Soup Co
ConAgra Foods Inc
Dean Foods Co
General Mills Inc
Hershey Co/The
HJ Heinz Co
Hormel Foods Corp
JM Smucker Co/The
Kellogg Co
Kraft Foods Inc
McCormick & Co Inc/MD
Mead Johnson Nutrition Co
Sara Lee Corp
Tyson Foods Inc
Packaged Foods & Meats Valuation

Trailing
P/E

Forward
P/E

Price to
Book

Price to Price to
Sales Cashflow

17.00
17.50
17.00
17.20
17.50

15.50
16.00
14.10
15.10
15.60

5.00
16.00
2.70
6.10
5.40

4.00
0.60
1.50
2.40
2.10

14.50
7.50
11.70
13.60
13.90

15.00
14.30
10.20
15.00
19.80
16.60
14.60
14.40
17.10
14.80
16.40
23.70
14.20
20.70
15.80

14.20
11.90
13.50
2.20
10.60
2.20
15.00
3.70
14.50
13.80
15.60
8.10
14.90
2.40
15.00
1.40
15.10
9.10
14.60
1.70
15.40
4.00
22.30 NM
13.10
3.40
13.00
1.60
15.20
2.80

1.60
0.90
0.30
1.60
2.00
1.40
0.80
1.60
1.60
1.30
1.60
3.80
0.80
0.30
0.90

11.40
10.00
5.40
11.50
14.90
12.50
10.90
10.70
12.90
11.70
12.50
21.00
8.40
8.80
11.50

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PepsiCo Company Report

Discounted Cash Flow (DCF) Analysis


Unlike valuation metrics such as the P/E ratio, DCF relies on free cash flows. It is a more reliable
estimate of a companys intrinsic value since it removes the accounting arbitrariness in
recognizing earnings and expenses. Regardless of whether a cash outlay is expensed or
capitalized, free cash flow is the money left over for investors.
A discount rate of 9.5% is used in the DCF model which the rate used for less risky defensive
sectors such as consumer staples. There is no indication from my research that PepsiCo is riskier
than the sector and that a higher rate is warranted. A growth rate of 4% is used assuming that the
companys long-term growth rate would be that of the market. The following are other
assumptions used in the construction of the model:
1

Revenue for the company for 2010 to 2012 is 8% on average reflecting the revenue
growth expectations for its business units. An average of 3.5% revenue growth for PAB, the
beverage unit, reflecting the below market growth of the beverage industry, an average 18%
growth for PepsiCo International as this business has been experiencing this type of double
digit growth which is expected to continue given that PepsiCo plans to expand its
international operations and an average of 6% growth for above market growth expectation
for its food and snacks unit, PAF.

Operating Income is projected at an average of 18% in the next three years as a


result of rolling up the projected revenues and operating costs of its three business units
and is consistent with the companys experience during the decade.

Interest Expense is based on the companys experience in the previous five fiscal
years and increasing to 1.2% of revenue as the economy grows and interest rates increase.
4
Depreciation is based on its historical relationship to revenue.
3

Tax for the current fiscal year is 28% based on the companys guidance during its
earnings call for its fiscal 2009 performance. The tax rate is projected to increase to 30%
given the deficits experienced by the countries in which PepsiCo operates.

Capital Expenditure for the current fiscal year is based on the companys planned $3.6
billion spending on this item, moving towards its historical rate relative to sales and finally
converging with the terminal depreciation rate.

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PepsiCo Company Report


Table 23 PepsiCo Discounted Cash Flow Model

Year

Revenue
% Grow th

Operating Income
Operating Margin

Interest and Other

Terminal Discount Rate =

9.5%

Terminal FCF Growth =

4.0%

2009A

2010E

2011E

2012E

43,232

56,661

61,260

67,100

-0.04%

31.1%

8.1%

8,044

10,549

18.6%

18.6%

2013E

2014E

2015E

2016E

2017E

2018E

2019E

71,126

75,038

79,165

83,123

87,280

91,207

94,855

9.5%

6.0%

5.5%

5.5%

5.0%

5.0%

4.5%

4.0%

11,096

11,992

12,447

13,132

13,854

14,547

15,274

15,961

16,600

18.1%

17.9%

17.5%

17.5%

17.5%

17.5%

17.5%

17.5%

17.5%

35

(578)

(625)

(684)

(854)

(900)

(950)

(997)

(1,047)

(1,094)

(1,138)

0.1%

-1.0%

-1.0%

-1.0%

-1.2%

-1.2%

-1.2%

-1.2%

-1.2%

-1.2%

-1.2%

2,100

2,792

3,141

3,803

3,990

4,210

4,441

4,663

4,896

5,117

5,321

26.0%

28.0%

30.0%

30.0%

30.0%

30.0%

30.0%

30.0%

30.0%

30.0%

30.0%

5,946

7,179

7,329

7,504

7,573

7,992

8,433

8,856

9,300

9,720

10,110

20.7%

2.1%

2.4%

0.9%

5.5%

5.5%

5.0%

5.0%

4.5%

4.0%

1,635

2,266

2,450

2,684

2,703

2,851

3,008

3,159

3,317

3,466

3,605

3.8%

4.0%

4.0%

4.0%

3.8%

3.8%

3.8%

3.8%

3.8%

3.8%

3.8%

(183)

277

33

47

(71)

(75)

(79)

(83)

(87)

(91)

(95)

-0.4%

0.5%

0.1%

0.1%

-0.1%

-0.1%

-0.1%

-0.1%

-0.1%

-0.1%

-0.1%

Subtract Cap Ex

2,128

3,598

3,369

3,355

3,556

3,602

3,642

3,657

3,666

3,648

3,605

Capex % of sales

4.9%

6.4%

5.5%

5.0%

5.0%

4.8%

4.6%

4.4%

4.2%

4.0%

3.8%

Free Cash Flow

5,270

6,124

6,444

6,880

6,649

7,166

7,720

8,274

8,864

9,446

10,015

16.2%

5.2%

6.8%

-3.4%

7.8%

7.7%

7.2%

7.1%

6.6%

6.0%

Terminal Value

189,378

Free Cash Yield

5.29%

Terminal P/E

18.7

Terminal EV/EBITDA

9.5

Interest % of Sales

Taxes
Tax Rate

Net Income
% Grow th

Add Depreciation/Amort
% of Sales

Plus/(minus) Changes WC
% of Sales

% Grow th

NPV of Cash Flows

46,750

38%

NPV of terminal value


Projected Equity Value

76,417
123,167

62%
100%

Free Cash Flow Yield

5.07%

Current P/E
Projected P/E
Current EV/EBITDA
Projected EV/EBITDA
Shares Outstanding
Current Price

17.5

14.5

14.2

20.7

17.2

16.8

11.1

8.4

7.9

13.1

9.9

9.3

1,653
$

62.89

Debt

7,400

Implied equity value/share $

74.51

Cash

3,943

18.5%

Cash/Share

2.39

Upside/(Downside) to DCF

2
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PepsiCo Company Report

Risks
1

There is the risk of missteps in integrating the two bottlers, the Pepsi Bottling Group,
Inc. (PBG) and PepsiAmericas, Inc. (PAS) preventing the company to fully realize the
benefits and cost savings expected from the acquisitions.

Currency risk increases as PepsiCo derives a greater proportion of its revenue


from its international operations.
3
PepsiCo operates in 200 countries exposing it to political risk. A recent example of such
risk occurred in early May when Venezuelan President Hugo Chavez seized a warehouse
owned
by Empresas Polar SA, the countrys largest food maker, which has a joint venture
8
with PepsiCo for the last 15 years to supply carbonated drinks in Venezuela.
4
Increasing commodity prices will affect PepsiCos performance since it is dependent on
agricultural commodity products. Prices are dependent on global demand and supply and are
sensitive to extreme weather conditions.
5

The impact of the European debt crisis could slow down the global economic growth
which can have an adverse effect on PepsiCos future revenue.

Conclusion
PepsiCo is a well managed company with well defined strategies to achieve growth in a mature
industry. From recent events and announcements, it seems that the company is making progress
executing on these strategies. It seeks to derive growth by expanding its operations
internationally which is evident in its recent announcement that it is investing $2.5 billion in
China, the fastest growing economy in the world. The company is leading the way in innovation
through R&D and its focus on health and nutrition in developing its products.
I have a buy recommendation on PepsiCo. Based on the discounted cash flow (DCF) model, the
target price for PepsiCo is $74 for the next year. This is a price appreciation of 18.5% on the
current price of $ 62.89, the closing price on May 28. With an additional 2.94% dividend yield,
total return is estimated to be 21.4%.

Source: Venezuelan Pepsi Seizure May Cut Supply, Montoya Says, May 4, 2010, Bloomberg.com
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