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PepsiCo Is Forging Ahead By Focusing On the Long Term

The beverage industry has undergone secular changes as health awareness among consumers has been on the rise. In the current challenging conditions for the beverage industry, PepsiCo (NYSE: PEP  ) has been taking aggressive steps to cut costs to support long-term earnings growth and reinvest savings in business.

Also, PepsiCo is focused on innovation and product differentiation, which is being supported by its marketing and advertisement efforts. As the beverage industry environment is challenging for everyone, Coca-Cola (NYSE: KO  ) is also working on making its cost structure leaner to support growth initiatives.

Trimming costs

PepsiCo has been consistently delivering stable growth in recent years, and it has grown its beverage and food businesses through geographical expansion, acquisitions, and innovation. Also, in the recent past, the company's global snacks business has been its main growth driver, whereas the growth of the beverage business has been relatively weak. In the recent first quarter, the company's global snacks organic revenue grew by 5% year over year, whereas global beverages organic revenue was up 3% and down 1% year over year on a reported basis in the first quarter of 2014.

As the company faces headwinds in the non-alcoholic ready-to-deliver (NARTD) category because of growing health awareness and obesity concerns, it has been working to make its cost structure leaner; it is making good progress with it cost-savings initiatives. The company realized operating margin expansion of 90 basis points and 37 basis points in 2013 and in the first quarter of 2014, respectively. Consistent with its productivity enhancement initiatives, the company expects to realize cost savings of at least $1 billion in 2014.

Moreover, PepsiCo has announced an incremental cost-savings program, which is expected to result in cost savings of $5 billion for the next five years, starting from 2015. The company expects to make its cost structure leaner through optimizing its production facilities globally, improving its go-to-market systems, increasing shared services, and investments in automation.

Coca-Cola is another beverage company that has been undertaking cost-control initiatives. Coca-Cola seems to be making progress with savings initiatives, as it experienced gross margin expansion of almost 50 basis points year over year in 2013. The company intends to reinvest the cost savings in the business, mainly toward increasing marketing spending, which will support sales volume growth. Recently, the company announced an additional $1 billion saving plan for the next three years. By the end of the recent first quarter, Coca-Cola had completed an operational excellence diagnostic of almost 50% of its manufacturing facilities in North America, and the remainder is expected to be completed by 2015. The initiative will result in cost savings of $1 million for each location. 

Reinvesting savings
PepsiCo also remains focused on product innovation and geographical expansion to support growth in the long term and to address challenges faced in the NARTD category. The innovation and expansion initiatives will be supported by the cost savings, as the money from that will be reinvested in the business. The company's focus on product innovation is evident from the fact that since 2011, its annual research and development investment increased by more than 25%. Also, in 2013 the company's nine products were part of the top 15 new food and beverage launches across all measured U.S. retail channels.

Moreover, in the recent first quarter, new products introduced by the company in the last three years made almost 8% of its total revenue. The company successfully introduced several new products, including Brisk Half and Half and Gatorade Fierce Blue Cherry. Sustainable innovation remains critical for the long-term success of the company.

Also, the company is supporting its existing brands and innovation with advertisement and marketing. Advertising and marketing spending remains important for the company to support sales volume growth. Advertising and marketing spending as a percentage of net sales increased from almost 5% in 2011 to 6% in 2013. Dr Pepper Snapple Group (NYSE: DPS  )

Dr Pepper's advertising and marketing spending has been aggressive and higher than its competitors, including PepsiCo and Coca-Cola. Dr Pepper has advertisement spending of almost 8% of net sales, higher than 6% and 7% for PepsiCo and Coca-Cola, respectively. Also, in the recent first quarter Dr Pepper's management indicated its advertisement spending to be 7.5% of net sales in 2014. The advertising and marketing spending will help beverage companies to support sales volume in the future.

Final take
PepsiCo has been taking corrective initiatives and making good progress to maintain a dominant position in the industry and to address the challenges faced in the NARTD category. The company's cost savings initiatives will help it reinvest in the business, supporting product innovation and advertising and marketing spending undertaken to support the existing brands and new product introductions.

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Furqan Asad

Furqan Asad mostly writes for the Consumer, Energy and Utility sectors. He has extensive experience in research and analysis and rigorous academic training from prestigious schools including London School of Economics. Furqan Asad has also passed all three levels of the CFA exam.

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8/27/2015 4:01 PM
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