Why PepsiCo Is a Smart Investment Despite Soda Sales Trends

You have to admire Indra K. Nooti. The chief executive of PepsiCo (NYSE: PEP  ) has stuck to her guns by holding onto the company's snacks division despite outside pressure from activist investor Nelson Peltz. The snacks business is attractively positioned to drive growth while the company continues to hold the line with beverages. 

PepsiCo Annual Report

PepsiCo has a major tailwind in its snacks division, which is comprised of familiar brands such as Doritos, Lays, and Tostitos, which are growing retail sales in the mid-single digits as of the first quarter. The reason? Despite the downward trend for sales of carbonated soft-drink beverages (and this despite fun summer Pepsi flavors made with real sugar being heavily marketed), salty snacks remain a constant in the American diet. 

Indeed, according to EuroMonitor International data cited in The Wall Street Journal, U.S. sales of salty snacks are outpacing those of ready-made meals, pasta, and soups, climbing 70% since the turn of the century. And salty snacks are the most popular afternoon snack, while at night they are second only to sweet treats, according to Hartman Group data cited in the Journal.

The rising demand for snacks was evidenced by PepsiCo's 2% organic volume increase in its global snacks division in the first quarter. PepsiCo's snacks business has offset slowing demand stemming from carbonated beverages, evidenced by a 1% decline in North American carbonated soft-drink volume in the first quarter. 

While snacks have been a bright spot for PepsiCo, this hasn't been merely a coincidence, despite the welcome tailwinds. PepsiCo has been investing in marketing its higher-priced specialty beverages including Mountain Dew Kickstart as well as its snacks. And PepsiCo plans price hikes of as much as 3% this year in its beverages and snacks divisions to drive sales higher, according to USA Today.

Last year, PepsiCo spent $2.7 billion on capital spending, representing a 3% increase year over year. In 2014, PepsiCo plans to direct $3 billion toward capital spending, or somewhere in the ballpark of 5% of revenue. Expect that type of spending to persist, as noted by PepsiCo CFO Hugh Johnston on the company's first-quarter conference call: "[W]e do not expect [advertising and marketing] as a percent of revenue to go down." 

This will help the company to remain competitive over, say, Dr Pepper Snapple Group, which has been focused on stemming capital spending in favor of hiking its dividend. 

That's not to say that PepsiCo is lifting capital spending at the expense of shareholder value -- quite the opposite. The company plans to return $8.7 billion to investors through stock buybacks and dividends this year, a 35% jump from last year's levels. 

Headwinds
Of course there are risks, even some that aren't so obvious. For instance, did you know that Wal-Mart in 2013 accounted for 11% of PepsiCo's net revenue? This includes Wal-Mart's warehouse store Sam's Club, whose same-store sales have been on a downward trend. If this trend persists, it could pressure PepsiCo's total net revenue, which only staged a 1% increase in 2013 year over year. And new taxes that went into effect in Mexico forced PepsiCo's hand in raising prices in the country, which in turn has led to declining volume in the developing economy. 

Of course, these macro issues aren't unique to PepsiCo. 

Foolish conclusion
Carbonated soft-drink companies are fighting to remain relevant, and it seems a diversified product portfolio is more important than ever in this industry. For PepsiCo and its snacks division, it has the wind at its back with the rising trend of salty snacking in the U.S., one that gives it an advantage over chief rival Coca-Cola. The stock is up 8.5% year to date and is trading at a forward P/E of about 18, outpacing Coca-Cola's 2.2% returns in the same period but basically inline with its rival's earnings multiple. Dr Pepper, whose returns this year rival those of PepsiCo, is trading at a pricier 21 times forward earnings.

PepsiCo has some attractive tailwinds, not to mention a nearly 3% dividend yield to keep investors satisfied despite the uncertainty surrounding the future of carbonated soft drinks. Barring any unforeseen change in direction, this is a stock to own for the long haul.

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