Beverage giant PepsiCo (NYSE: PEP ) has been struggling under the weight of its underperforming beverage unit. The division has anecdotally been hurt by a consumer shift away from carbonated beverages, a trend that has had a similar impact on competitor Coca-Cola (NYSE: KO ) . The challenge of finding top-line growth in the current environment has led to a difficult period for PepsiCo's stock price, evidenced by a below-market 5% gain over the past 12 months.
Nevertheless, at least one investor sees gold in the company's mix of brands, activist investor Nelson Peltz and his Trian Fund Management. He has been trying to force a split of PepsiCo's snacks and beverage units for some time now. Management, though, has been fighting a split, believing that the two halves of its business provide synergies and cross-selling opportunities. So, should investors bet on some upside for PepsiCo?
What's the value?
Along with Coca-Cola, PepsiCo is a dominant player in the global beverage business, primarily through its trademark Pepsi carbonated-beverage brand. In response to changing consumer behavior, the company has also wisely broadened its beverage offerings over the years, adding major positions in the energy and fruit juice segments, including its Gatorade and Tropicana brands, respectively. In addition, PepsiCo has diversified its revenue mix by building a complementary snacks business, a segment that currently accounts for roughly half of its total sales.
Not surprisingly, PepsiCo's financial results were pretty tepid in its latest fiscal year, highlighted by a 1.4% revenue increase that was negatively affected by a sales volume decline in its key North American beverage business.
On the upside, though, the company generated a sales volume increase in its higher-margin snacks business, which enabled it to engineer a slight pickup in its overall adjusted operating profitability. The net result for PepsiCo was continued strength in its operating cash flow, helping to fund new product development across its brands, notably Tostitos Cantina chips and Mountain Dew Kickstart soda.
Another data point
Of course, things aren't much better over at Coca-Cola, a competitor that is wholly dependent on the beverage business. It generates roughly three-fourths of its revenue from carbonated beverages, including nearly half from its trademark Coca-Cola brand. While Coca-Cola eked out an overall sales volume gain in its latest fiscal year, it posted a sales volume decline in its key North American carbonated-beverage business, which capped its top-line revenue growth.
More importantly, the company's increasingly apparent inability to attract higher volumes of customers to its sugary carbonated beverages has management thinking outside of the box. This led to its recent partnership with Keurig Green Mountain to develop a cold-beverage machine, a deal that is designed to give Coca-Cola a prime position in the at-home market.
A better way to go
With a share position estimated at less than 1% of PepsiCo's shares, Trian seems to have an uphill battle in its fight to split up the company. Thus, investors need to evaluate PepsiCo as an integrated enterprise, an exercise that should reveal a highly profitable company that is weighed down by weak growth for its beverage business, especially in the carbonated-beverage area.
Given the preceding discussion, investors looking for growth in the beverage business should probably follow Coca-Cola's example and target opportunities in the fast charging at-home space, like SodaStream (NASDAQ: SODA ) . With annual sales of roughly 4.4 million machines, the company is the king of the at-home carbonated-beverage segment, primarily selling its products through 60,000 retail partners in 45 countries around the world.
In its latest fiscal year, SodaStream continued to follow its top-line growth trajectory of the past few years. It reported a 29% increase that was aided by double-digit growth in sales of both its machines and related accessories, mostly refill cartridges and flavor packs. The company's operating margin was negatively affected by the costs of expanding its support network in key markets, notably the U.S. But SodaStream remained net cash flow positive during the period, which allowed it to continue building a solid global infrastructure without taking on debt.
That infrastructure will be increasingly critical, given SodaStream's obvious size disadvantage in marketing spending relative to the beverage giants, and will hopefully help the company to maintain its momentum and leading position in the global at-home market.
The bottom line
PepsiCo likely has a conglomerate discount, as Trian has alleged. But unlocking that potential value will be a neat trick given management's unwavering opposition. As such, investors are left with the prospect of going upstream with the whole enterprise, a trek that is probably fraught with more risk than reward.
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