PepsiCo's Capital Allocation Strategy Does Not Bode Well For Future Returns

Nov. 13, 2020 11:21 AM ETPepsiCo, Inc. (PEP)KO53 Comments


  • Although PepsiCo and Coca-Cola are often considered as two very similar companies, they have gone in very different directions.
  • PepsiCo seems to be missing out on the coffee business, which could be a costly mistake in the long term as soda consumption declines.
  • Masked under the so far well-performing snacking division is PepsiCo's troubled beverage business, which does not seem to be heading in the right direction.
  • All these risks would most likely not manifest themselves in PepsiCo's next quarterly results, but could prove fatal for long-term returns.

Source: PepsiCo CAGNY 2020 presentation

PepsiCo (NYSE:NASDAQ:PEP) has been outperforming its major peers over the past decade. As a dividend aristocrat with both stable and high return on capital, the company has become a key component in many retail and institutional investors' portfolios.

ChartData by YCharts

Although PepsiCo is unlikely to suffer heavy losses over the short term, shareholders holding the company for the long run should not focus whether or not the company meets or beats quarterly estimates. The success of such large enterprises in the stable packaged food and beverages space is not determined by the operational decisions taken on a day-to-day basis. Long-term success depends on making the right strategic capital allocation decisions which could provide tailwinds for share prices for years, if not decades, ahead.

To begin with the stable nature of PepsiCo's earnings and its low risk for shareholders has pushed the company to become one of the most highly-leveraged businesses in its large cap peer group.

Source: Prepared by the author using data from Seeking Alpha and annual and quarterly SEC Filings

The high leverage is not a problem from an operational point of view but it could become one, if the company's long-term capital allocation strategy does not pay off. Down below I will first cover some key differences between PEP and its major peers and will then focus on the key long-term risks that the company is now faced with.

How PepsiCo stacks against its major peers

Although often seen as very similar companies, KO and PEP have become very different businesses over the years. To begin with, half of PEP sales are derived from its snacking business, while KO is a pure play beverage company. The latter is also becoming a much more asset-light business, following the divestment of a large proportion of its bottling operations.

This article was written by

Vladimir Dimitrov, CFA profile picture
Investment strategy for those seeking steady and above-market returns

Vladimir Dimitrov is a former strategy consultant with a professional focus on business and intangible assets valuation. His professional background lies in solving complex business problems through the lens of overall business strategy and various valuation and financial modelling techniques.

Vladimir has also been exploring the concept of value investing and in particular finding companies with sustainable competitive advantages that also trade below their intrinsic value. He supplements his bottom-up approach with a more holistic view of the markets through factor investing techniques.

Vladimir made his first investment in farmland right out of high school in 2007 and consequently started investing through mutual funds at the bottom of the market in 2009. In the years that followed he has been focused on developing his own investment philosophy and has been managing a concentrated equity portfolio since 2016. Vladimir is LSE Alumni and a CFA charterholder . 

All of Vladimir's content published on Seeking Alpha is for informational purposes only and should not be construed as investment advice. Always consult a licensed investment professional before making investment decisions.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MDLZ over 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: Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication and are subject to change without notice.

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