By Jeff Fischer (TMF Jeff)
June 13, 2000

Trading at $41 1/4 as of June 9, 2000

One childhood memory I have is my father standing in the family room after work, just before dinner, chomping on a few potato chips. Another memory is dad, after dinner, chomping on some potato chips or popcorn during the evening news. Still another memory is the Saturday, late-morning snack sneak: chomp, chomp, chomp. And then during lunch. And sometimes after. And then on Sunday during sporting events. And at night while reading a book (which is why I gave him Amazon.com in 1998). All in all, it is amazing that my father is still slim and in shape.

What stock should sit beside the Amazon shares? PepsiCo (NYSE: PEP).

With $20 billion in annual sales, Pepsi operates in two key businesses, one of which has flat-out excellent economics, the other of which has very good economics. The excellent business is snack foods. Pepsi owns Frito-Lay, which dominates the US snack food market and many international markets, and accounts for 70% of Pepsi's net profits. The very good business is soft drinks. Pepsi beverages, including Mountain Dew, control about 33% of the U.S. market compared to Coca-Cola (NYSE: KO) at around 45%. (Pepsi also owns Tropicana, the leading orange juice.)

Being number two in the soft drink business is nothing to be ashamed of, while dominating the snack food business deserves a standing ovation.

Now, since my father loves snack food and my mother loves Pepsi, shares of the company could fit perfectly into their home and portfolio. And, with about six years before dad's retirement, I wouldn't hesitate to put a bit of his money in the snack food king for the duration (and longer, assuming he won't need it to cruise the world!). Pepsi is on track to grow earnings per share 16% in the current quarter and up to 13% annually at least the next two years -- assuming management can continue to land its punches. It has hit the target so far.

Under a new CEO since 1996, Pepsi spun-off its low margin restaurant businesses and bottling plants, juiced up Pepsi's advertising campaign, grew revenue annually (while Coca-Cola's has drifted) and increased Frito-Lay's volume consistently. In the process, operating margins have gained 500 basis points since 1996, rising from 10% to 15%, and return on invested capital (ROIC) has risen to 20% from 15%. The company is becoming a leaner, meaner, more-profitable cash flow machine -- a machine with a serious, protective "moat" around its main snack food business.

In tandem with the potential for market-beating earnings per share growth at least in the intermediate term, Pepsi also offers relative stability. Founded in 1898, the company is here to stay.

At a recent $40 per share, $58-billion Pepsi yields a 1.4% dividend and trades at 28.5 times year 2000 earnings estimates and 25.3 times year 2001 estimates. This earnings multiple puts Pepsi at a slight discount to the S&P 500 index's multiple. But, if the new Pepsi can demonstrate consistent earnings growth in the next few years, its stock will almost certainly command a premium price compared to the general market. So, chomp away on those chips, Dad. As an investor, it's like paying yourself with every bite. But, do buy the new baked, low-fat chips!

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