PepsiCo Shows Why Frito-Lay and Pepsi Are Better Together
Pressure is mounting on PepsiCo and Coca-Cola to find ways to grow amid declining carbonated soft drink sales in the United States. Noted investor Nelson Peltz is pushing PepsiCo to spin off its beverage business and buy Mondelez International .
The combination of Frito-Lay -- which derives most of its revenue from the United States -- and Mondelez -- which operates internationally -- would create a global snacks powerhouse. However, what is good for Peltz, whose Trian Fund owns stakes in PepsiCo and Mondelez, may not be good for the rest of PepsiCo's shareholders. In fact, even Coca-Cola might prefer to be in PepsiCo's position.
Breaking down the numbers PepsiCo owns the No. 1 position in salty snacks, hot cereals, and sports drinks and the No. 2 position in juice and carbonated soft drinks. Its overall revenue is split 50/50 between food and beverages.
Operating profit, however, is not so evenly split. Frito-Lay's Americas operations are split into two segments: Frito-Lay North America, or FLNA, and Latin America Foods, or LAF. FLNA and LAF reported a combined $4.8 billion in operating profit during 2012 for a 22% profit margin. PepsiCo Americas Beverages, or PAB, reported $2.9 billion in profit for a 14% operating margin. FLNA, LAF, and PAB represent a combined 74% of overall operating profit, making them the three most important segments in the business.
In addition to being more profitable than the other segment, FLNA has been growing faster than PAB; organic FLNA growth was 3.5% in 2012, which compares to 1.5% for PAB. More significantly, FLNA profit increased by 1% in 2012 while PAB profit declined 10%.
If you got lost in all the numbers, the basic idea is this: PepsiCo derives a substantial majority of its profit from North America and the snacks business is in better shape than the beverages business. This is why Peltz believes Mondelez would be a good fit for Frito-Lay and that PepsiCo should spin off its beverages unit.
Mondelez derives only 20% of its sales from North America, with most of the rest coming from faster-growing emerging markets. Its blockbuster brands include Cadbury, Chips Ahoy, Ritz, Oreo, Nabisco, Wheat Thins, and others. Mondelez holds leading market shares in every category and every country in which it competes, which includes the top global market share in biscuits, chocolate, and candy and the No. 2 share in gum and coffee.
Mondelez would provide exposure to higher-growth markets and the spin-off of the beverage unit would unburden PepsiCo from a major drag on profitability. However, that may not make the transformation a good idea.
Coca-Cola would like to own Frito-Lay If it had its druthers, Coca-Cola would probably like to own PepsiCo's Frito-Lay division. Coca-Cola's Americas operations are only slightly less profitable than Frito-Lay's Americas business. The real attraction is not just that Frito-Lay represents a source of growth amid stagnant beverages sales, but that snacks and beverages go so well together . PepsiCo CEO Indra Nooyi defended the beverages unit in an interview on CNBC by noting that when you eat a salty snack, like Fritos, you also reach for a beverage. She said, "These two categories are better together, not just in the United States, but around the world." PepsiCo markets and distributes snacks and beverages together, leveraging its scale and the complimentary aspects of the two.
Coca-Cola, on the other hand, must make due with its beverages business. Although the world's largest soft drink company is expanding its beverages portfolio to include healthier brands like Odwalla, Zico, and Evian, it still relies on sugary beverages for the vast majority of its profits; its top four brands are Coca-Cola, Diet Coke, Fanta, and Sprite. Moreover, it derives 45% of total revenue from North America, where sugary drinks are under attack over health concerns. Although many observers believe that soft drink profits will rebound in 2014 following a return to rational pricing, Coca-Cola would still rather have a close complimentary product to distribute with its soft drinks to leverage its existing infrastructure. So it is understandable why PepsiCo would want to hold onto such a valuable combination.
Bottom line Indra Nooyi is emphatic that she will not spin off PepsiCo's beverage unit and combine Frito-Lay with Mondelez. The latter combination would turn the company into an unmatchable snacks powerhouse, but the beverage-snacks combination is an interesting pairing of complimentary products. Either combination would put the company in a position to build shareholder value for decades, but shareholders should be pleased that Nooyi is sticking with the tried-and-true beverage and snacks business. Why change what's already working?
Is PepsiCo a stock to own forever?
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love.
The article PepsiCo Shows Why Frito-Lay and Pepsi Are Better Together originally appeared on Fool.com.Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of Coca-Cola and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.