PepsiCo: Fighting At All The Ends

| About: PepsiCo Inc. (PEP)

PepsiCo (PEP), one of the largest food and beverage companies, declared its second-quarter results on July 24, 2013. Its net revenue grew by 2% despite a decline in consumption of soda drinks in the U.S. Soda drink sales are declining in the U.S. due to increasing health concerns. However, PepsiCo's presence in the snacks food market helped support the revenue growth. Declining sales of soft drinks, led PepsiCo to focus on its premium bottled water segment and the emerging Indian market.

Betting big on Indian market

The company is facing tough competition from Indian companies like Balaji Wafers, Yellow Diamond, and ITC in the Indian snacks market. It has been losing its market share in the Indian snacks market, declining from 69.7% in 2008 to 56.8% in 2012. PepsiCo's flagship brands like Kurkure and Lays' market shares declined by 2%-3% during April-September 2012. However, the Indian market is one of the major growth drivers for PepsiCo's Asia, Middle East & Africa, or AMEA, division. The Indian snacks market is rapidly growing and stood at approximately $1.44 billion in 2012. According to Euromonitor's projections, India's snacks market is expected to be worth $4.2 billion by 2018.

Balaji Wafers is the biggest threat to PepsiCo's snack business in India. Balaji operates on a low cost model and its products are sold at a low price as $0.08. Balaji provides higher margins to distributors for selling its products, as it does not spend huge money on running television advertisements. It has a strong distribution network of 700 distributors and 800,000 stockists across four states of western India, and it is looking to expand in north and south India. Its market share has increased to 13.7% in 2012, from 9.5% in 2008.

Since emerging markets like India have potential to grow faster than developed markets, the company has been aggressive on regaining market share through new product launches and competitive pricing. PepsiCo launched 25 new products last year, and it's now focusing on low-price packaging with the launch of Lays mini packs of 12.5gm at $0.08 to reach a larger consumer base in urban and rural markets. The company is pushing back look-alike rivals of Kurkure priced at $0.08 per pack through advertisements. There is also news that PepsiCo may acquire a 25% stake in Balaji wafers and leverage Balaji's distribution channel in western India to reach customers.

Water as an alternative for soft drink

According to a study published in the American Journal of Public Health, soft drink consumption causes overweight, obesity and diabetes. U.S. residents have cut down consumption of soft drinks due to increasing awareness about its negative effects on health. Per capita consumption of carbonated soft drinks, or CSD, was at a peak of 54 gallons per year in 1998 and it has declined to 44 gallons in 2013. From 1998 to 2013, per capita water consumption increased to 58 gallon per year. PepsiCo's North America beverages segment is feeling the heat due to declining CSD consumption. PepsiCo's sales in the North America beverage segment declined 4.5% in the second quarter.

Amid the decline in CSD consumption, Pepsi plans to enter the premium bottled water segment in the U.S. It is expected to launch its "Om" brand of premium water next year following the popularity of Coca-Cola's (KO) "Smartwater." Smartwater sales, in terms of quantity sold, increased 16% in the first half of this year over last year. PepsiCo already has a presence in the bottled water segment with Aquafina, which accounts for 10% of the U.S. bottled water market. However, "Om" will introduce a Pepsi presence into the premium bottled water segment. The U.S. bottled water market grew 6.7% from $11.05 billion in 2011, to $11.8 billion in 2012. Per capita consumption of bottled water is showing positive signs for the bottled water segment in the U.S., and it increased by 5.3% to 30.8 gallon in 2012. The FDA considers bottled water a consumer food product. It does not provide any product differentiation, which makes it a less profitable business for beverage companies. However, beverage companies can earn more by marketing products and building brand recognition. Premium bottled water undergoes various purification stages and companies add additional minerals. Thus, the premium bottled water segment provides product differentiation, and PepsiCo can charge customers a premium price to earn better margins.

Valuation

Based on recent quarterly results, PepsiCo fairs better among its competitors. Its revenue grew by 2% year over year whereas, Coca-Cola and Dr Pepper Snapple Group's (DPS) second-quarter revenue declined by 3% and 1% respectively. Pepsi trades at 18.71 times earnings, relatively cheaper than Coca-Cola. PepsiCo's earnings per share, or EPS, of $4.25 is considerably better than its competitors' EPS.

PepsiCo

Coca-cola

Dr Pepper Snapple Group

Second quarter revenue growth (year-over-year)

2%

-3%

-1%

P/E (NYSE:TTM)

18.71

20.34

15.22

Forward P/E

16.79

17.02

13.58

EPS

4.25

1.90

2.93

Click to enlarge

Source: Yahoo Finance

Moreover, PepsiCo approved a new share repurchase program for share repurchase of $10 billion by June 2016. The company is expected to return a total of $3 billion in share repurchase and approximately $3.4 billion in dividends to its shareholders by the end of this year. The company has the capability to return this to shareholders with $7.79 billion cash and cash equivalents on its balance sheet as of June 2013.

Conclusion

PepsiCo's entry into the premium bottled water segment is late, compared with its rival Coca-Cola. Once Om launches, it will take some time to build a brand image in the premium bottled water segment. Meanwhile, PepsiCo's aggressive pricing to regain market share in the Indian snacks market may increase its consumer base in the near future. Also, the company's regular dividend payments indicates its growth potential in the future. Overall, wait and watch is the best strategy before investing in PepsiCo.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Madhu Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.