Frito-LayCo. Er, PepsiCo.
The snack chip, soda a go-go giant

by Jeff Fischer (TMF Jeff)

Alexandria, VA (August 12, 1999) -- PepsiCo(NYSE: PEP) has been undergoing a reformation for four years and it is now, by all appearances, beginning to build momentum under its new business model. Having siphoned off its depreciation-heavy retail restaurant assets via the $10 billion Tricon Global (NYSE: YUM) spin-off in 1997, the number-two soda seller has since been free to focus on lighter, higher-return businesses. It has two: Web hosting and pogo sticks.

Wait. Cut. Re-take.

It has two: snack foods and beverages.

If PepsiCo were named based on the most important of the two divisions, the name of the company would change to Frito-LayCo. The dynamics of the beverage industry are attractive, but the snack food industry is at least equally attractive, and PepsiCo's domination of it is downright scandalous. Frito-Lay holds 57.5% market share this year, up from 55.3% in 1998. The closest competitor is Procter & Gamble (NYSE: PG) with a slim 6.5% market share year-to-date, down from 7.4% last year. In snack products, P&G sells Pringles.

PepsiCo's Frito-Lay division lays claim to 81% of the top brands by volume in the country. 81%. That makes Coca-Cola's (NYSE: KO) 44% hold on the domestic beverage market appear tepid and flat. Frito-Lay's best sellers include Lays, Ruffles, Doritos, Tostitos, Fritos, Chee-tos (being a fan, Brian always has bright orange fingers), and Rold Gold. Diehard Cracker Jack fans should know that PepsiCo also owns Cracker Jack. In the second quarter ended June 30, 1999, Frito-Lay North America grew volume 3.5% and profits 12%. This division represents over 60% of PepsiCo's operating profit.

This year, snack food should bag $2.0 billion in profit at PepsiCo and beverages will cap about $1.1 billion in profit. Tropicana, bought from Seagram in 1998 for $3.3 billion, should add $155 million in profit to the beverage division, while soda (primarily Pepsi, its derivatives, and Mountain Dew) should add $906 million. Pepsi's sodas are enjoying better growth than Coca-Cola's this year, with case volume up 3% last quarter versus Coca-Cola's 2% decline. Coca-Cola's volume ailed in Europe (it was down 6%) following the widely publicized, company-specific health scare. However, Coca-Cola's volume declined in North America, too, falling 1%. This was blamed on a price increase by bottlers.

Pepsi grew case volume 3% partially thanks to a Star Wars promotional tie-in, its newly launched Pepsi One soda (Brian drinks it constantly), and strong sales of its new bottled water, Aquafina. Aquafina added nearly one percentage point to Pepsi's three points of volume growth.

All three of Pepsi's divisions (commonly seen as snack foods, beverages, and Tropicana) performed above expectation in quarter two, and profitability measures are improving overall. Pepsi's return on equity (return on equity measures the amount of income generated relative to the net dollars invested in company assets, or shareholder's equity) was recently 34% versus Coca-Cola's 45%. PepsiCo's net profit margin was 9% versus Coca-Cola's 18%.

The company is working to improve profitability levels by cutting costs, raising prices almost in-line with Coca-Cola's increases, and strengthening product lines, and also via the ongoing process of restructuring its business. This year, management tore a page from Coca-Cola's book and sold a 65% stake in its bottling operations to you -- the public.

For more information on Pepsi, please see (or revisit) our initial overview of the company and a following article on its valuation. Interestingly, the valuation has not changed in the 19 months since the article. Next, post your thoughts on PepsiCo on the Drip Companies message board. We've only just scratched the surface.

Initial conclusion: PepsiCo operates in businesses that are as attractive as Coca-Cola's (it just isn't as profitable yet), and it trades at a considerably lower valuation than Coca-Cola -- not that Coca-Cola is an accurate gauge to use to measure fair valuation, but it is a measure nonetheless. Brian will share his thoughts tomorrow and we'll continue to forage into the Pepsi jungle next week.

To close, ThePup posted this question on the Drip message board today, titled: "Adding one more!". If you have thoughts to Foolishly share with him (ThePup, that is), please post 'em.

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8/12/99 Close

Stock      Close       Change
JNJ         94 3/4      +2 3/4
INTC      75 15/16      -1/16
CPB        44 1/16      -1/16
MEL         31 5/8      - 1 
              Day     Month       Year     History
Drip        (0.11%)    3.92%     9.74%      24.81% 
S&P 500     (0.29%)   (2.30%)    6.19%      38.30% 
Nasdaq      (0.60%)   (3.37%)   16.27%      59.96% 

Last Rec'd    Total #    Security    In At    Current
 08/02/99      8.174        CPB      $52.750   $44.063
 07/01/99     21.066       INTC      $41.861   $75.938
 03/09/99      9.076        JNJ      $74.910   $94.750
 06/07/99     22.453        MEL      $33.488   $31.625

Last Rec'd   Total # Security   In At     Value    Change
 08/02/99     8.174     CPB     $431.18   $360.17  ($71.01)
 07/01/99    21.066    INTC     $881.84  $1599.69  $717.85 
 03/09/99     9.076     JNJ     $679.89   $859.95  $180.07 
 06/07/99    22.453     MEL     $751.91   $710.09  ($41.82)

Base:  $2800.00
Cash:    $24.27**
Total: $3554.17

The Drip Portfolio has been divided into 113.904 shares with an average purchase price of $24.582 per share.

The portfolio began with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to have $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging, we don't expect to seriously challenge the S&P 500 for the first 3 to 5 years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. (NOTE: our investment in Campbell Soup is all but frozen due to fees instituted in its DRP plan.)

**Transactions in progress:

7/26/99: Sent $100 to buy more JNJ.