Soft drink stocks: PepsiCo

– Analysts: Bill Schmitz Jr./Eric Katzman, Deutsche Bank

PepsiCo Inc.’s (PEP-NYSE, $76.69, Consumer Products Sector) product portfolio is “a tale of two cities”, with beverages struggling as snacks thrive, according to Deutsche Bank analysts Bill Schmitz Jr. and Eric Katzman.

In addition to the Pepsi brand, the company also produces and distributes products under brands such as Tropicana, Quaker Oats, and Frito-Lay.

Messrs. Schmitz and Katzman note that snack foods make up more than 60 per cent of Pepsi’s enterprise value, determined by subtracting its total cash and equivalents from its market capitalization plus any debt, minority interests, and preferred stock.

For the fourth quarter of 2013, Pepsi reported core earnings-per-share of $1.05, beating consensus estimates, say the analysts. The company reported core earnings-per-share of $1.02 for the same period in 2012, translating to a 3.6 per cent increase.

The company enjoyed overall organic sales growth of 4.1 per cent year-over-year, to $20.118 billion, but that growth was inconsistent.

For example, Pepsi’s fourth-quarter Latin American food sales rose 3.8 per cent to $2.818 billion compared to a year earlier and its operating profit grew by 6.1 per cent to $419 million. However, its beverage sales in the Americas fell 1.6 per cent year-over-year to $5.982 billion and operating profits for that segment dropped 9.6 per cent to $688 million.

The analysts say that Pepsi’s soft drink brands have struggled in the U.S. as well as globally, specifically carbonated soft drinks. Although the company’s board members recently considered selling or spinning off its beverage assets, they ultimately decided to hang on to those brands, they add.

Commenting on the company’s strategy going forward, Messrs. Schmitz and Katzman say that for the time being, Pepsi seems content to treat its growth-challenged North American beverage assets as a cash cow, using their high free cash flow to increase productivity programs and cash payouts to shareholders.

In the meantime, Pepsi will rely on its strong snacks category and emerging markets to drive the bulk of sales growth.

The company has unveiled a fairly conservative target for organic growth in 2014, aiming for a percentage in the mid-single digits. It also projects seven per cent earnings-per-share growth, as counted in local currencies.

Pepsi’s ongoing productivity improvements and lower pension contributions and taxes should help the company weather tough market conditions, say Messrs. Schmitz and Katzman.

The analysts maintain a “buy” recommendation for Pepsi. Their target share price still stands at $90 as well.


Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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