PepsiCo: Making Right Strategic Decisions To Secure Long-Term Growth

| About: PepsiCo Inc. (PEP)

Summary

The company is making correct strategic decisions to secure long-term growth.

The company's U.S. snacks and beverages segments will continue to deliver healthy performance.

Stock is trading at a forward P/E of 20x, in contrast to its peers' average forward P/E of 21x.

Increasing health awareness among consumers has adversely affected carbonated soft drinks sales in the recent years. PepsiCo (NYSE:PEP) and other food companies in the U.S. are making aggressive efforts and growth investments to alter their product portfolio to keep up with changing consumer demands. The company's performance in the future will be supported by its strong U.S. beverages and snacks businesses. Also, the company's initiatives to improve its productivity will augur well for its profit margins. However, the company's international business performance will remain weak in the near term due to lack of scale and execution challenges. The company needs to consistently make growth investments to strengthen its product portfolio, which will allow it to secure long-term growth and augur well for the stock's valuation. The stock is trading at a forward P/E of 20x, in contrast to its peers' average forward P/E of 21x.

Financial Performance and Catalysts

The company delivered better-than-expected performance for 3Q16. PEP reported EPS of $1.40, beating the consensus of $1.32. Also, EPS for the quarter increased 4% YoY. Revenues for 3Q16 came out to be $16.03 billion, 1% higher than the consensus estimate. The company's strong performance for 3Q16 was driven by strong results of its U.S. beverages and snacks businesses. PEP is targeting EPS of $4.78 for 2016, as compared to the previous target of $4.71. The company experienced 2% organic volume growth at its Frito-Lay segment, and its beverage volumes were up 2% in the North America for 3Q16. In the upcoming quarters, the company will continue to deliver healthy performance despite the challenges it is facing in the carbonated soft drinks category.

As carbonated soft drinks sales are declining due to a shift in consumer preferences towards healthy alternatives, the company is rebalancing its beverage portfolio towards non-carbonated soft drinks which are growing at a faster rate. The company's North America's beverage segment will continue to stay healthy due to its strong non-carbonated beverages brands which are increasing at a rate of almost 4%, offsetting the 2% decline in carbonated soft drinks sales. The company has the leading market position in tea, coffee, sports drinks and juice categories in the U.S. As the company will continue to focus on strengthening its non-carbonated soft drinks portfolio through innovation, its top line growth will improve. The company is targeting more than 25% of its sales to be generated through products which were launched in the last three years.

Furthermore, the company's U.S. food business will continue to deliver strong performance and will outperform North American peers. The company's strong snacks brands and growing snacks market in the U.S. present attractive growth opportunities. Also, the company's U.S. Frito-Lay North American segment generates higher operating margin of almost 30% as compared to Mondelez's (NASDAQ:MDLZ) operating margin of 20%. The company should continue to rebalance and strengthen its product portfolio consistent with consumer demands, which will help it to offset the decline in the carbonated soft drinks category and fuel growth in the long term. The following chart shows the company's U.S. beverages and snacks segments have delivered strong performance in the recent quarters.

Click to enlarge

Source: Bloomberg.com

The company's international beverage business performance will remain weak in the near term due to execution challenges. The company should increase growth investments to strengthen its international beverage business. Also, it should focus to improve its distribution network for its international beverage segment. As the company will continue to solidify its product portfolio, its top-line growth will improve, which will augur well for the stock's valuation. The stock is trading at a forward P/E of 20x, in contrast to its peers' average forward P/E of 21x.

Summation

The company is making correct strategic decisions to secure its long-term growth. PEP's efforts to diversify and rebalance its product portfolio will allow it to offset the carbonated soft drinks sales decline and secure long-term growth. The company's U.S. snacks and beverages segments will continue to deliver a healthy performance, which will fuel long-term growth. However, the company's international beverages segment's performance will be challenged in the near term mainly due to execution challenges. As the company will continue to execute its growth plans, the stock valuation will expand.

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