Pepsi (PEP) Symbol: PEP Exchange: NYSE Industry: Processed & Packaged Goods Sector: Consumer Goods Purchase Price: $43. 12 Purchase Date: December 2002 52week High $78. 09 52week Low $61. 89 Initial Floor 2 $74. 26 Trailing Floor 3 $77. 87 Beta N/A Market Cap $123. 11 billion Shares Outstanding 1. 61 billion Dividend Yield 1. 50% P/E Ratio 20. 49 Competitor #1 Coca-Cola (KO) Competitor #2 Cadbury Schweppes (CSG) Type of Security: Large Cap Growth Predicted Shareholder Return 1 year: 14. 1% Past 5 years: 34. 53% Past 10 years: 128% Predicted Annual Return: 4. 9% Strategic and Competitive Analysis The first point of analysis which should be examined when using Porter’s five forces is the competition within the industry. Pepsi has varying degrees of competition in their different sectors. In their carbonated beverage sector Pepsi really only has one major competitor; Coca-Cola. Cadbury Schweppes is also a competitor, but Cadbury is in the process of selling off their carbonated beverage sector. The major competition Pepsi has to deal with in this sector is Coca-Cola, thus creating a sort of Duopoly.
The competition is slightly minimized however because of the product differentiation. Many avid soda drinkers will say that there is a difference between Pepsi and Coke, and both have their own secret recipes. Unfortunately for Pepsi, the market is not a complete duopoly because of substitutes. It is also intensely competitive. Pepsi does have a differentiated product in the carbonated soft drink sector but there are substitutes; store brands. This limits Pepsi’s ability to raise prices.
As a result, Pepsi’s price increase ability is limited to inflation that will presumably affect all producers of carbonated soft drinks (assuming all have similar hedging strategies). Pepsi’s other products experience different competition. The Frito-Lay brand’s major rival is Proctor and Gamble, and again, store brand substitutes. However, Frito-Lay has had a very successful marketing program in past years, and revitalized their brand image for Doritos and Sun Chips. Both of these products are very differentiated and there are few substitutes for Doritos and currently none for Sun Chips.
Pepsi’s product differentiation caused by their marketing strategies has severely limited the threat of new entrants. Also, the heavy start up costs of manufacturing and packaging plants would be a deterrent. Still, the biggest deterrent is brand image and reputation; a new company would be very hard pressed to take market share away from an established brand like Pepsi or its affiliates. SWOT Pepsi’s strategy is to meet consumer demand by introducing new products in order to increase market share. The demand for carbonated soft drinks has been decreasing as consumers focus more on healthy substitutes.
PepsiCo recently acquired sparkling juice company IZZE. The firm has also signed a licensing agreement with Ben & Jerry’s for the sale of milkshakes and a deal with Starbucks to distribute its Ethos water brand. It has launched a coffee-flavored cola, Pepsi Max Cino, in the U. K. The company has also entered into a joint-venture with Starbucks in China. Pepsi is allowing Starbucks to sell its beverages in its current distribution centers in an attempt to capture a portion of the implementation of “grab-n-go” coffee in Asian markets.
In addition, Pepsi is participating in a marketing campaign to be shown on the flat-screen televisions that line the walls of subway cars in Shanghai. The marketing ploy is interesting because it involves short clips of a movie, or “subopera,” to be shown in small segments over forty weekdays. The movie is a love story and apparently, is not shy about showing both the Starbucks and Pepsi logos. Marketers in the US and Asia believe this method will be effective, as it fits with the trendy and upscale Asian subway audience.
Bowing to obesity concerns in the U. S. , Pepsi has developed an interest in the health and wellness of its customers and has declared a commitment to meeting people’s changing tastes. Hence, it is striving to reformulate its products to include more nutritional ingredients. The company developed the S. M. A. R. T lifestyle program, involving five steps to a healthier living, and plans to build 12 Smart Spot playgrounds in inner city locations across the country. Pepsi’s broad strategy of meeting customer’s changing wants and desires will be successful.
However, each specific new product or product development depends on Pepsi’s ability to identify, gauge, and properly assess changing environments. Pepsi appears to be going in the right direction by shifting their focus from carbonated to noncarbonated beverages as well as by focusing on healthier alternatives. Pepsi’s second main strategy is to grow and expand internationally. There is more room for growth internationally due to emerging foreign markets, including Asia and India. Pepsi has proven a success in the international arena and should continue to develop.
International sales have greatly increased the value of Pepsi, as a decline in US currency brings higher exchange rates for international business. Pepsi’s focus on their international businesses has paid them well during a market correction, which has stemmed from massive deferrals on adjustable-rate mortgages. Pepsi’s main competitor in the drink business is Coca Cola and in the snack market the major competitors are Proctor and Gamble and General Mills. The nonalcoholic beverage industry is maturing but is deep in stiff competition. It has a history of price wars.
Pricing, advertising, innovation, marketing, new packaging, as well as brand and trademark development and protection determine the pecking order. Additionally, differentiation is the key to success for most beverage companies. Coca Cola is the number one soft drink maker but given Pepsi’s selective market carbonated soft drink strength (Middle East, Russia, China, India, Thailand, Egypt, Venezuela, Nigeria) and the relative affordability of carbonated soft drinks, growth from this portion of the portfolio will continue to be realized in the near term.
Furthermore, with a strengthening global carbonated soft drink portfolio, Power of One (P. O. 1. ) promotions can potentially drive incremental sales. This is illustrated by the graph below. (KEEP GRAPH) This graph also brings to light another reason Pepsi has an advantage over Coke; it’s product portfolio is diversified. In fact, the company has greater revenues from salty snacks. As is the case with carbonated soft drinks, there is greater opportunity for growth internationally.
With relatively deeper market penetration than its primary competitors and a strong correlation between consumption and GDP per capita levels, the core salty snack portfolio has been the primary component of revenues and profits for Pepsi International. Pepsi may not be the best in the soft drink business; however, PepsiCo is not only in the soft drink business. This diversification provides a less risky competitive advantage as well as greater opportunities for growth. This makes it better because it allows greater avenues for growth and expansion as well as a greater cushion for possible blows to demand in the soft drink industry.
Most companies in the soft drink industry should see benefits from pricing gains and new product contributions, which should outweigh rising input costs. Price spikes in high fructose corn syrup and citrus juices could materialize in 2007. However, analysts expect the industry index to outperform the broader market over the next 12 months, reflecting improvement in volume trends as companies increase marketing spending behind core brands. Also, the industry has both room for continued expansion (ever changing demand and thus product expansion opportunities) and steady and safe sales.
Consumers will always need to drink and snack, and will not change their consumption habits because of the rising price of oil. If anything, consumers will eat out less and snack more. If they do eat out more, soft drink companies such as PepsiCo supply the drinks at restaurants. This provides a natural hedge to this type of situation, but it is more illustrative of the general constant demand for Pepsi’s products. Analysis of 3rd Quarter Earnings Conference Call On September 8th, 2007, Pepsi held an earnings conference call to discuss their recently released 2007 Q3 earnings.
Those present among company management included; Indra Nooyi – President, CEO, Richard Goodman – CFO, John Compton North America CEO, Dawn Hudson – North America President, Michael White International Vice Chairman, CEO, and Jamie Caulfield – IR. They were to give formal presentations on the Company’s earnings and answer questions from analysts. For the past 36 weeks, Pepsi’s total servings increased 4%, with worldwide beverages growing 4% and worldwide snacks growing 6%. This is due to a higher concentration of products in emerging foreign markets.
Net revenue increased 10% primarily reflecting positive effective net pricing across all divisions, as well as our volume growth. The impact of acquisitions, such as Umbro, contributed over 2 percentage points to net revenue growth and foreign currency contributed 2 percentage points. Pepsi’s total operating profit increased 11% and margin increased 0. 1 percentage points. The operating profit performance reflects leverage from the revenue growth, partly offset by the impact of higher raw material costs. Corporate unallocated expenses decreased 2. 5% reflecting lower pension costs of $13 million and foreign exchange gains of $9 million.
Pepsi’s bottling equity income increased 6% primarily reflecting higher earnings from anchor bottlers. Net interest expense increased $9 million primarily reflecting the impact of lower investment balances and higher average rates on our debt, partially offset by lower average debt balances and higher average interest rates on our investments. Pepsi’s net income increased 15% and the related net income per share increased 17%. These increases primarily show solid operating profit growth. Also, net income per share was also positively impacted by share buy-backs.
Frito Lay North America Pepsi’s Frito Lay N. America division’s net revenue grew 6% reflecting volume growth of 2. 5% and positive effective net pricing. Pound volume grew primarily due to double-digit growth in trademark Doritos, SunChips, dips, and multipack. Overall, salty snacks revenue grew 6% with volume growth of 2. 5%, and other macro snacks revenue grew 10% with volume growth of 4%. Operating profit grew 7% driven by the net revenue growth. The operating profit growth was partially offset by increased advertising and marketing expenses, as well as higher commodity costs.
Pepsi-Co Beverages North America BCS volume was flat due to a 3% decline in CSDs, fully offset by a 4% increase in non-carbonated beverages. The decline in the CSD portfolio reflects a minor decline in trademark Pepsi and a low decline in trademark Mountain Dew, offset slightly by a small increase in trademark Sierra Mist. The non-carbonated portfolio performance was driven by double-digit growth in Lipton ready-to-drink teas and double-digit growth in waters and enhanced waters under the Aquafina, Propel and SoBe trademarks, partially offset by a small decline in Gatorade and a relative decline in the juice and juice drinks sector.
Net revenue grew 4% driven by effective net pricing, primarily reflecting the price increases on Tropicana Pure Premium higher-priced non-carbonated beverages. Acquisitions contributed 2 percentage points to net revenue growth, while operating profit increased 4% reflecting the net revenue growth. Pepsi-Co International International snacks volume grew 9%, led by double-digit growth at Gamesa in Mexico, as well as double-digit growth in Russia. However, there were small declines at Sabritas in Mexico and at Walkers in the United Kingdom. Additionally, India grew at a double-digit rate.
Overall, the Europe, Middle East & Africa region grew 10%, the Latin America region grew 7%, and the Asia Pacific region grew 19%. The acquisition of a business in New Zealand in the first quarter of 2007 increased the Asia Pacific region volume by 10 percentage points. In all, acquisitions contributed 2 percentage points to the reported total PepsiCo International snack volume growth rate. Beverage volume grew 8%, led by double-digit growth in Pakistan, Russia, China and the Middle East, partially offset by a slight decline in Mexico and a mediocre decline in Thailand.
Pepsi’s Europe, Middle East & Africa region grew 10%, the Asia Pacific region grew 8%, and the Latin America region grew 4%. Net revenue grew 20%, reflecting the volume growth and favorable effective net pricing. Foreign currency contributed 5 percentage points of growth primarily reflecting the favorable euro and the British pound. Operating profit grew 21% driven largely by the volume growth and positive effective net pricing, partially offset by increased raw material costs. Foreign currency contributed 4. 5 percentage points of growth prominently portraying the British pound and euro changeover rate.
Quaker Foods North America Net revenue increased 4% and volume grew 1%. This volume increase primarily reflects slight growth in Oatmeal and Cap’n Crunch cereal. These increases were partly offset by a decline in Rice-A-Roni, Life cereal, and Pasta Roni. Positive net pricing increased the net revenue growth, while operating profit increased 2%, reflecting the net revenue growth, which was offset by higher raw material costs. Principal Executives Ms. Indra K. Nooyi , 51 Chairwoman, Chief Exec. Officer and Pres Pay: $3. 96M Exercised: $0 Mr.
Richard Goodman , 58 Chief Financial Officer Pay: $1. 17M Exercised: $0 Mr. John C. Compton , 44 Chief Exec. Officer of North America and Member of Liquid Refreshment Beverage Oversight Council Pay: $2. 13M Exercised: $17. 00K Ms. Cynthia M. Trudell , 53 Chief Personnel Officer and Sr. VP Pay: $100. 00K Exercised: N/A Mr. Donald M. Kendall , 86 Co-Founder Pay: N/A Exercised: N/A NET SHARE PURCHASE ACTIVITY Insider Purchases – Last 6 Months (Thompson Financial) Purchases Sales Net Shares Purchased (Sold) Total Insider Shares Held % Net Shares Purchased (Sold)
Shares 28 371,872 (371,844) 885. 34K (29. 7%) Trans 1 7 8 N/A N/A Net Institutional Purchases – Prior Qtr to Latest Qtr Net Shares Purchased (Sold) % Change in Institutional Shares Held Analyst Recommendations Date 11/14/07 10/9/07 7/30/07 4/27/07 4/12/07 2/16/07 2/8/07 Research Firm Credit Suisse Deutsche Sec. Matrix research Matrix research Bernstein Gold m a n Sachs Stifel Nicolaus Action Initiated Downgrad e Upgrad e Downgrad e Upgrad e Upgrad e Downgrad e Buy Hold Buy Mrkt p erform Neutral Buy From To Outp erform Hold Buy Hold Outp erform Buy Hold
Shares (600,967) (0. 1%) PRICE TARGET SUMMARY (Thompson/First Call) Mean Target: 80. 15 Median Target: 80. 00 High Target: 92. 00 Low Target: 75. 00 No. of Brokers: 13 Professional Funds BREAKDOWN % of Shares Held by All Insider and 5% Owners: 0% % of Shares Held by Institutional & Mutual Fund Owners: 68% % of Float Held by Institutional & Mutual Fund Owners: 68% Number of Institutions Holding Shares: 1319 TOP INSTITUTIONAL HOLDERS Holder Shares CAPITAL RES. 104,375,468 Barclays Global 59,128,098 STATE STREET 48,825,783 VANGUARD 45,969,688 BANK OF AMER. 7,296,401 FMR CORP 33,617,030 NY Mellon Corp. 25,211,479 NORTHERN 24,497,670 WELLINGTON 23,749,526 GOLDMAN 23,258,399 TOP MUTUAL FUND HOLDERS % Out 6. 48 3. 67 3. 03 2. 86 2. 32 2. 09 1. 57 1. 52 1. 48 1. 44 Value* $7,646,546,785 $4,331,724,459 $3,576,976,862 $3,367,739,342 $2,732,334,337 $2,462,783,617 $1,846,992,951 $1,794,699,304 $1,739,890,274 $1,703,910,310 Reported 30-Sep-07 30-Sep-07 30-Sep-07 30-Sep-07 30-Sep-07 30-Sep-07 30-Sep-07 30-Sep-07 30-Sep-07 30-Sep-07 Reported 30-Sep-07 30-Sep-07 0-Sep-07 30-Jun-07 30-Jun-07 30-Sep-07 30-Jun-07 30-Sep-07 30-Jun-07 30-Sep-06 Holder Shares % Out Value* WASHINGTON Mut. 18,302,568 1. 14 $1,340,846,131 INVEST. CO. OF AMER. 18,250,000 1. 13 $1,336,995,000 GROWTH FUND 17,738,100 1. 10 $1,299,493,206 VANGUARD 500 15,371,834 . 95 $996,863,434 COLLEGE* 13,424,307 . 83 $870,566,308 FIDELITY CONTRA. 12,583,573 . 78 $921,872,557 VANGUARD TOT. 9,645,980 . 60 $625,541,803 CAPITAL INCOME 8,795,000 . 55 $644,321,700 VANGUARD INST. 8,699,887 . 4 $564,187,671 SPDR TRUST 7,865,453 . 49 $513,299,462 * = College RETIREMENT EQUITIES FUND-STOCK ACCOUNT Macroeconomic Review & Stock Market Pepsi must promote its product diversity, size, and growth prospects in the upcoming fiscal quarters. The current credit crisis in the US, which stemmed from adjustable-rate mortgages, can play a certain role in Pepsi’s strategy. The large size of Pepsi will shield the company from the effects of the credit crisis, such as higher interest rates and initial principal payments.
Because of this correction, the Federal Reserve has cut the interest rate three times in the last three months in an effort to encourage banks to borrow more freely from the Fed at a time when there are worries that a rising number of bad loans will prompt banks to tighten credit conditions too severely, adding another strain on the already fragile US economy. The stock market entered a euphoric state as stocks rose each time the fed cut the rate, before coming to a correction in late November. Creditors will be more willing to allow Pepsi to borrow based on their free cash, net income, and global market share.
Pepsi can use this result to maintain and expand into its growth opportunities as companies focus on repayment of credit, rather than inherent growth. Although Pepsi faced high material costs in recent quarters, its global sales furthered growth potential and brought strong revenue. Pepsi should be able to uphold its market share in the US despite an economic slowdown because its products don’t incur a high financial commitment. In other words, a consumer will buy soda and chips despite high interest rates and a rising price in oil. These products deem Pepsi a “recessionproof” company as it can strongly face cyclical economic events.
Pepsi has benefited from its global market and international sales because of the decline in the US dollar to foreign currencies. Its international businesses provide a positive changeover rate from most nations as currency is turned into American dollars. Pepsi can use this availability of credit and boost in international sales to further expand into emerging foreign markets, such as India, who provide beneficial growth opportunities for consumer discretionary companies. Sales Considerations SMIP should consider selling this stock when one or more of the following conditions are met: 1.
When there is a severe increase in costs due to inflation specific to these inputs. 2. When Pepsi is no longer able to increase prices to cover increasing costs. 3. When Pepsi begins to lose significant market share to competitors – represented by slower revenue growth compared to competitors. 4. When the stock reaches the initial or trailing floor. 5. When international growth slows down significantly. 6. If there is a massive swing towards healthier foods, in which Pepsi’s products lose their initial competitive advantages in taste and brand recognition.