2014 has, thus far, been an impressive stretch for PepsiCo (PEP -0.41%). Its stock is currently up roughly 14% YTD, due largely to growth from its Frito-Lay division offsetting a decline in carbonated beverages. Pepsico delivered a solid earnings beat with the Oct. 9 release of its most recent quarterly report. The period produced better-than-expected revenue and net income, and prompted the company to raise its fiscal-year targets.
The beverage and snack company actually stands as the largest growth driver in U.S. retail sales in the current calendar year. Even with its strong performance, Pepsi is facing cultural headwinds that threaten its business. The company will need to invest intelligently in its future if it hopes to maintain and improve its market position. Pepsi hasn't given breakdowns or guidance on its estimated $3 billion in 2014 capital expenditures by category, but the following areas are key points of focus for the company.
Product innovation and maximizing the benefits of scale are a big focus
Pepsi's business must contend with shifting demographics and an increasingly health-conscious public as it maps out its future growth. As sugary, carbonated beverages continue to receive increasing scrutiny, the company is devoting significant resources to adapting its product line to the shifting market and ensuring that it can deliver high margin sales. At February's CAGNY conference, PepsiCo America Foods CEO Brian Cornell pointed to the company's product research at its Frito-Lay flavor kitchens as a major investment. This is a capital expenditure that has the potential to create significant upside for Pepsi, as the company looks to be increasingly reliant on dominating the snack segment. This year's spending represents a more than 7% increase over the roughly $2.8 billion allocated in 2013.
PEP Capital Expenditures (Annual) data by YCharts
Developing new flavors and products gives the company the opportunity to grow its business domestically and abroad. 2012 saw PepsiCo open a new innovation lab in China, its biggest research institute outside North America, and efforts to create products that appeal to regional tastes helped the company sell a record number of potato chips in 2013. This year and beyond, the company is investing to drive its Quaker oatmeal brand to a market leading position in the country. Globally, Pepsi is devoting resources to encourage the pairing of its Quaker products with its Naked, Tropicana, and Starbucks branded drinks.
2014 marks the third consecutive year that Pepsi has increased its advertising and marketing spend. Pepsi is also investing to maximize and leverage the advantages that its scale provides. One area that the company is focused on in this area is improving automation capabilities. Improving supply chain execution is another big focus, as slow growth in the highly important North American market highlights the need to improve business efficiency and drive higher margins.
Brand building and realizing the "Better Together" strategy
Pepsi's business depends on the strength of its brands, and the company continues to devote resources to strengthen its established commodities in addition to launching new ones. With the beverage and snack markets in flux, the company is allocating capital to gain a better understanding of consumer habits and improving product synergy. Pepsi's "Better Together" initiative sees the company attempting to encourage the pairing of its soft drink and snack products. This strategy has already seen considerable success in the home market, as 60% of Mountain Dew households also purchase its Doritos chips. It's also been successful in the outside-the-home segment, particularly with the Doritos Locos tacos collaboration with Yum! Brands' Taco Bell chains, and PepsiCo is currently developing new menu items in conjunctions with Buffalo Wild Wings. Strong performance from these food items benefits Pepsi at multiple levels, as it also encourages the sale of the company's beverages at restaurant locations. The pull of Doritos Locos appears to be waning, so investing in future menu collaborations with Pepsi-affiliated chains seems to be a smart move.
Is Pepsico's $3 billion investment in its future the right move at the right time?
Pepsi projects that its estimated net capital expenditure of $3 billion will come in at less than 5% of its 2014 revenue. Free cash flow for the year is estimated to be $7 billion, so the company seems to be clearing enough cash to justify its capex investment, even in light of aggressive efforts to return value to shareholders. Its most recent dividend payout represented the company's 42nd consecutive annual increase, and the company has already returned $6 billion in value YTD. It expects to have returned $8.7 billion by the end of the year, with dividend payments of $3.7 billion and $5 billion in share repurchases. While the extent of the share repurchases might raise some eyebrows, the capital that Pepsi is investing in its business this year looks to be money well spent.
