PepsiCo Is A Long-Term Play For Value Investors

| About: PepsiCo Inc. (PEP)

Recently, Katy Perry, a famous American singer and actress, has been highly criticized by the Center for Science in the Public Interest and six other organizations for promoting Pepsi. The consumer health advocates accused that she is exploiting her popularity by promoting something that causes disease in her fans. "Drink Pepsi and you will be cool like Katy Perry" was the takeaway message that brought the celebrity under fire.

Previously, Beyonce, another popular American star, was slammed for endorsing Pepsi as it is considered to be a major contributor to childhood obesity by health advocates.

This criticism has led to the declining popularity of soda drinks in North America. To avoid criticism and to cater to new consumer preferences, many leading fast-food restaurants like McDonald's and Burger King are now focusing more on milk shakes and juices and less on carbonated drinks; especially in their kid menus.

The trend is slowly chipping away at the three major market players; PepsiCo (NYSE:PEP), Coca-Cola (NYSE:KO) and Dr Pepper Snapple Group (NYSE:DPS) as these companies have experienced a considerable decline in their carbonated drinks sales in the previous quarters.

To make the situation even worse for these companies, many governments have recently increased taxes on soda drinks including the Mexican government, the UK government and the San Francisco municipal government. The governments' campaigns to combat obesity and diabetes will hurt soda consumption in these regions and eventually decrease the earnings of soda manufacturers.

However, PepsiCo has an edge over its competitors as it has the most diversified portfolio compared to other players in the industry. The company's food and beverage portfolio consists of 22 brands compared to its main rival Coca-Cola which deals only in beverages. The company is organized into four business units: PepsiCo America Foods (PAF), PepsiCo America Beverages (PAB), PepsiCo Europe and PepsiCo Asia, Middle East and Africa (AMEA). Besides carbonated drinks, it offers a range of snacks, non-carbonated beverages, dairy products and other foods.

Third Quarter 2013 Results

During the third quarter of 2013, the company's performance in the beverage category was depressing. The net revenues in the PepsiCo Americas Beverages segment declined 2% YoY primarily due to a 5% volume decline in North America. The carbonated soft drinks segment faced a 6% decline in this region while the carbonated drinks declined by 3%.

Beverage volume in the European segment declined 1% on a yearly basis. The only segment in which beverage volume grew was AMEA. The volume in this segment increased 7% reflecting a double digit growth in China and Pakistan. However, the growth was negative in India and the Middle East.

The decrease in the beverages category was offset by other segments of the company. The net revenue increased 5% in the Frito-Lay North American segment and 3% in the European segment (driven by a 3% volume increase in snacks). The volume of the snacks category in the AMEA region also grew by 4% compared to the results of the same quarter in 2012. The total revenues of the company increased 1.54% on a year-over-year basis. During the first three quarters of 2013 the increase in revenues was 1.67%.

The net earnings in the third quarter increased by approximately 58 more basis points than the net earnings of 3Q12. During the first three quarters of 2013 the net earnings improved and increased by 10.64% compared to results of the first three quarters of 2012.

Coca-Cola's reported net revenues in the third quarter 2013 declined 2.5% YoY whereas during the first three quarters of 2013 the net operating revenues declined around 2%, due to lower interest expenses and higher other income. Coca-Cola's net earnings increased by approximately 6% in 3Q13 compared to 3Q12. During the first nine months of 2013, the company's total net earnings declined by approximately 4% primarily due to lower revenues than those generated in the first nine months of 2012.

The results of these two rivals show that PepsiCo received substantial gains due to its expanded portfolio. The decline in PepsiCo's beverage segment was offset by its other segments but Coca-Cola does not have any other segments to offset its negative revenue growth. This factor mitigates PepsiCo's risks in the long run.

Liquidity Position and Debt Profile

The table below shows stats from PepsiCo and Coca-Cola's Q3 '13 balance sheets and cash flows. The current ratio shows that PepsiCo is more efficient in turning its products into cash and is better equipped to pay its short-term obligations with short-term assets than Coca-Cola. Coca-Cola's current ratio is under 1 which denotes the company's poor liquidity and inability to pay its liabilities.

PepsiCo's debt-to-equity ratio is higher than Coca-Cola's but a higher interest coverage ratio ensures that the company is better equipped to pay interest on its outstanding debt compared to its rival. However, both companies need to improve their revenue generation to satisfy interest expenses since they both have an interest coverage ratio below 1. This could create problems for both companies in the future.

A higher cash flow-to-debt ratio suggests that PepsiCo is able to cover debt obligations from its operating cash flows better than Coca-Cola.

Final Takeaway

The continuous criticism from health advocates, changing consumer preferences in mature markets and imposition of taxes from governments will create challenges for soft drink manufacturers. It is expected that due to tax impositions PepsiCo will face a decline in beverage sales in Mexico and the UK where it experienced positive volume growth in the last reported quarter.

However, the company's expanded portfolio will mitigate risks and bring more opportunities for growth especially in South Asian and other developing economies. Through its diversified portfolio the company will have more avenues to enter into new markets and create footholds. This will increase PepsiCo's profitability in the future and give the company a competitive advantage.

The company's liquidity position and its ability to pay obligations are also better than its rival Coca-Cola. Therefore, in my opinion, PepsiCo's stock offers attractive opportunities for investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.