PepsiCo: 'All-Natural' Growth

| About: PepsiCo Inc. (PEP)
Every so often, it's nice to listen to management speak at conferences or analyst days to get a sense of the overall direction of the company, which is usually only briefly touched upon during quarterly calls. Last week’s appearance by two key PepsiCo (NYSE:PEP) executives at the Morgan Stanley Consumer & Retail Conference was such an occasion.
While integrating the bottlers has been a focal point, PepsiCo has continued to drive growth by implementing new product variations to meet consumer demand for “good-for-you” products. For those familiar with the story, PepsiCo entered into the all natural business (meaning no artificial colors, no preservatives, no artificial flavors, and made with all-natural ingredients) in 2010 when they converted their entire Lay's Kettle business and Lay's flavors business. The reasoning is simple enough: give consumers what they want. As noted during the presentation by John Compton, CEO of PepsiCo Americas Foods:

We have talked extensively to consumers about this idea, and they come back and tell us the number one motivation for purchase is products that claim to be all natural.

From looking at the results for the initial rollout, it's clear that there is unmet demand in this segment. The Lay's potato chip business has grown roughly 8% since the all natural rollout, compared to a food and beverage category that has booked less than 1% growth. On top of that, Lay’s grabbed an additional 1.7 share points during that same time frame, which is impressive expansion in the highly competitive potato chip segment. It is worth noting that the Frito-Lay North America (FLNA) segment accounted for nearly a third (31%) of PepsiCo’s total net revenue in 2009; this is clearly an integral part of the business looking forward.
Based on this early success, PepsiCo is set to make a big push into all natural in 2011. The platform will be expanded to include Tostitos, Sun Chips, and Rold Gold, as well as Fritos in the back half of the year. When all is said and done, more than 50% of the Frito-Lay portfolio will be launching all natural next year. This shift has helped to draw in a crowd that tends to avoid “junk food”. As noted by Mr. Compton, “...the purchase intent went up for heavy users, medium users, and importantly, light users who tend to come and go from the category.”
The other area where PepsiCo has made significant changes is through the bottler acquisitions. As much as management loves to talk about synergies (who doesn’t?), I would rather discuss this purely from a consumer perspective. Naturally, potato chips (salty) and LRB’s (refreshing) go together; with a portfolio composed of both components, PEP has a chance to leverage these products (they have #1 or #2 position in over practically every category) by creating promotions based on complementary purchases. PepsiCo has made a big push recently into an initiative called “the Power of One”, which looks to take this business strategy—combining the offerings of its multiple food and beverage brands—to a whole new level. As noted by Eric Foss, CEO of Pepsi Beverages Company, “Only 50% of salty snack occasions include a liquid refreshment beverage, and only 10% of beverage occasions include a salty snack.” If PepsiCo can leverage the brand and the “Power of One” to increase the percentage of complementary purchases between these two categories by consumers they would be in an even stronger position to grow both revenues and profitability (the two combined have annual sales at retail of $230B).
Economies of scale don’t only apply to operations. For a company with the size and product demand such as PepsiCo, economies of scale can be used to incentivize retailers to be all ears with concerns to new product launches. While most companies would have little say over such matters, PepsiCo is the #1 or #2 contributor to revenue, profit, and cash flows for most retail customers; naturally, they will be heard if they feel the need to be. This combination of unmet demand and retailer cooperation makes me extremely optimistic for the continued success in the future by PepsiCo in the push towards $30 billion in sales for good-for-you products by 2020.

Disclosure: Long PEP