April 27, 1999

PepsiCo Inc. for Mom

by Selena Maranjian (TMFSelena@aol.com)

Trading at $36 3/4 as of April 26, 1999

Mom, have I got a stock for you! You're a cook and baker extraordinaire, so you'll appreciate a company that specializes in labor-saving kitchen technology. It's called eMeringue (ticker: HAFD), it sells meringue pie tops via the Internet, and...

...oops. I think I'm a little late for that. On to Plan B. (But anyone reading this who hasn't checked out the above link is doing themselves a disservice.)

First of all, Mom, I'm sorry about the stock I recommended last year. Like any other investor, I have my great investments and regrettable ones. Perhaps, over time, InVision (Nasdaq: INVN) will redeem itself. Perhaps not, though.

This year, I thought I'd go with a more conservative pick. It's a little-known snack and beverage company called PepsiCo (NYSE: PEP).

Let me highlight what most people probably know about the company:

-- It's a soft-drink powerhouse. (To be precise, it's ranked #2 in the U.S. with 31.4% of the market.)

Okay. We're done. That's probably what the average American knows about this remarkable firm. But there's much more.

-- It also owns the significant Frito-Lay brand, a flagship in its snack foods line. What else is in this line? Well, name a major potato chip brand. Ruffles? It's PepsiCo. Lay's? Also PepsiCo. Think of some other popular treats. Cheetos? Doritos? Sun Chips? Tostitos? Smartfood Popcorn? WOW! fat-free snacks? Rold Gold pretzels? You guessed it -- all PepsiCo. (Grandma's Cookies and Funyuns, too.) The wonderful thing about the snack food business is how profitable it is. Each bag of fried potatoes or popped corn is just that -- a bag of an inexpensive product, inexpensively made. It sells for plenty more than it costs to produce. Pepsi's snack line accounted for 63% of its 1998 operating profits.

-- PepsiCo also has more than just Pepsi and Diet Pepsi in its portfolio of potables. There's 7UP (international), All Sport, Aquafina, Frappucino (with Starbucks), Lipton Brisk and Brew (with Lipton Tea), Mirinda (international), Mountain Dew, Mug, Pepsi One, Slice, and Storm. This business is about to get much more attractive, financially speaking, as the company is spinning off its more capital-intensive bottling operations. What will be left is the relatively simple job of making syrup for sodas.

-- Name the world's best-selling orange juice. If you said Tropicana, you're right. And I won't even ask you to guess who bought it in 1998, because I think you've got the idea by now. (It bought Cracker Jack in 1998, too.)

We wouldn't be too Foolish if we didn't look at a few numbers. So here are a few:

Fiscal year:              1998        1997      1996 
Revenues*                 22,348     20,917   20,337
Gross margin (%)              58         59       58     
Operating margin (%)          12         13       10       
Net profit margin (%)        8.9       10.2      5.6    
Return on equity (%)          18         32       16    
Return on Inv. Capital: (%)   16         18       17     
# of shares repurchased*    59.2       69.0     54.2    
Sh. outst. at year-end*    1,471      1,502    1,545

*in millions
(To crunch more numbers, check out Pepsi's website. It features several annual reports full of valuable information.)

Pepsi has stepped up its share repurchase program in recent years. These buybacks increase the value of remaining shares and make shareholders happy. Shareholders were also made happy in 1997, when PepsiCo spun off its restaurant business that featured some blockbuster brands: Pizza Hut, Taco Bell, and KFC (the new way to say Kentucky Fried Chicken without using the out-of-vogue word "fried"). The new company is called Tricon (NYSE: YUM.) The restaurant business can be terribly capital-intensive, leading to lower margins and returns on assets. Setting these divisions free lightened Pepsi's business model considerably.

In addition, in November, Pepsi's board of directors authorized the sale of a majority stake in its (also capital-intensive and asset-heavy) bottling group. Pepsi's business model will grow lighter still.

Here are a few other things to consider:

-- International opportunity. The average American downs more than 50 gallons of soft drinks per year. The world average, though, is less than 10 gallons. China and India, accounting for much of the world's population, drink much less than that. But things are changing. International volume for Pepsi grew 6% last year. The situation is the same for snack chips -- except there's no major multinational competitor.

-- Even little brands are thriving. Mountain Dew volume has jumped more than 70% in the past year. Mug root beer and cream soda grew 20%. Newly released Pepsi One appears to be selling well.

-- Pepsi leads in convenience store and gas station sales. It's gaining share in drugstores. Fountain and restaurant sales are also growing, as are sales in all distribution channels.

-- Pepsi Cola gained market share in the last year.

In case everything is looking too good to be true, let me remind you of a few risks.

-- The company has taken on a lot of debt recently. It aims to pay it down in short order, though, with proceeds from bottling transactions.

-- It competes with a mighty powerful rival -- Coca-Cola.

-- It does considerable business abroad and is vulnerable to global economic crises. (In 1998, about 26% of sales came from international divisions.)

Bottom line -- should you buy this stock? Well, that's up to you. Please don't take this as a recommendation to take any action without first doing your own due diligence. The 1998 annual report is easy to read and very informative. After some homework, you may find that PepsiCo looks likely to add a little fizz and snap to your portfolio.

PepsiCo Company Information:
Trades on NYSE under symbol PEP
PepsiCo's website: www.pepsico.com
Current Quote
PepsiCo's Chart

Other Related Links:
PepsiCo Message Board
PepsiCo vs. Coke Dueling Fools -- 4/21/99

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