PepsiCo Could Be a Better Investment

PepsiCo Could Be a Better Investment

Whenever investors and consumers think about PepsiCo , most of them think about one of the largest soft drink players in the world, second only to Coca-Cola . In the U.S., Coca-Cola has as much as 42% share of the total soft drink market, while PepsiCo's market share is around 28.1%. However, the majority of PepsiCo's profit and growth come from its snack business, not from the beverage business.

Snack business is the bigger business
In the past nine months, PepsiCo's net revenue rose by 4%. This was thanks to a 3% organic growth in the company's snack business, while the beverage business delivered only 1% organic growth. In terms of profit, the company generated nearly $4 billion in operating profit from its Americas Food segment, while the Americas Beverage business contributed nearly $2.3 billion in profit. The biggest segment, Frito-Lay North America, has posted 3% volume growth and 4.5% organic revenue growth since the beginning of the year.

Although PepsiCo raised its advertising and marketing expenses for Frito-Lay North America, the core operating margin increased by about 35 basis points year-to-date. The company believed in the potential growth of this snack business, led by its innovations such as Doritos Jacked Ranch Dipped Hot Wings, Cheetos Mix-Ups, and Tostitos Cantina.

Creating more value via Mondelez's merger
Nelson Peltz, a famous activist investor, sees the potential for PepsiCo's Frito-Lay business. He laid out two strategic alternatives for PepsiCo. The company can either merge with emerging food leader Mondelez International and separate the beverage business from the food business, or it can separate the beverage and snack business into two different companies. Mondelez currently holds the global market-leading positions in several categories, including chocolate, biscuits, and candy.

Nelson Peltz thought that the first option was the best for PepsiCo for three reasons. First, the two companies could realize as much as $3 billion in revenue synergies and an additional $3 billion in cost synergies, as well as margin improvement for Mondelez. Second, it could create the emerging market snack global leader with the most valuable brand portfolios in the world. Third, the merger could create an opportunity for efficient capital structure and significant capital return.

Mondelez is trading at around $32.30 per share, lower than the proposed takeover offer of $35 per share by Nelson Peltz. With the potential synergies and operating leverage, he thought that the implied value per share will be around $175 for PepsiCo and $72 per share for Mondelez, along with the 20% of the combined company to shareholders.

Coca-Cola enhances its leading position in the beverage business
While PepsiCo's product portfolio is more diversified with the snack and beverage businesses, Coca-Cola has kept its focus on strategies to enhance its leadership position in both carbonated soft drink and the non-alcoholic ready-to-drink market. In the third quarter, the company reported sequential volume growth for the 25th consecutive quarter. Its flagship brand Coca-Cola grew by 2% in the quarter as well, indicating the brand's strength on a global scale.

Because of the 2% global volume growth, Coca-Cola was able to deliver 181 billion servings in the quarter. Muhtar Kent, the chairman and CEO, said that the company was on track to reach its 2020 Vision of doubling its business from its 2010 base. Coca-Cola believed that there would be a lot of potential growth in the market due to increasing urbanization, growing disposable income, and the rising middle class. With its well-established global distribution network and global leading position, Coca-Cola is in the right position to take advantage of those favorable macro trends to grow its business.

My Foolish take
PepsiCo could definitely benefit from the merger with Mondelez and/or the separation of its snack food and beverage businesses. The separation would create the two global leaders: one in the snack business and the other in the beverage business. With the activism of Nelson Peltz, I personally expected that there will be a lot of value delivered to PepsiCo's shareholders in the near future.

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Anh HOANG 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.

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