With more than $20 billion in annual sales, PepsiCo (NYSE: PEP) will be challenged to grow its earnings per share 11% or more annually over the coming years. However, the company's girth also aids its growth. A company of this size, like Johnson & Johnson (NYSE: JNJ), has far more levers that it can pull, push, and manipulate in order to steer earnings growth in the right direction and at the right speed.
A company this large can find more ways to cut costs, too, using economies of scale and new technologies. For one, the Internet, which is something that both Pepsi and Johnson & Johnson are beginning to use internally, should cut costs significantly for companies. Oracle Corp. (NYSE: ORCL) is the best example. It has chopped $1 billion in expenses from its books. This can lead directly to higher earnings growth.
In Pepsi's case, year-over-year growth can also be wrung out of the business by selling underperforming divisions (as Pepsi has done with bottlers), by tightening inventory to increase inventory turns, by finding more efficient ways to distribute its interrelated products -- beverages and snack foods -- by pricing, and by cross-promoting products in ways that cut marketing costs.
In a nutshell, Pepsi -- along with all of the other qualities that we have attributed it in the past -- has four key things working for it as it strives to achieve long-term double-digit earnings growth:
- Economies of scale
- Incredibly strong and related brands (Frito-Lay and various beverages)
- Many levers and switches that it can utilize
- Renewed focus
Under CEO Roger Enrico, Pepsi has been pulling and pushing the right levers and now results are starting to "click." Under Enrico's hand, since 1996 the company sold its restaurant businesses, bought Tropicana (an early success already) and spun-off bottling businesses. In the process, Enrico has brought Pepsi's focus to just two things: snack foods and beverages.
Much as Coca-Cola (NYSE: KO) emerged in 1989 after selling -- of all things -- its movie studio division, Pepsi has emerged with a renewed focus as well. In the early going, it is paying off. Operating margins have gained 500 basis points since 1996, rising to 15% from 10%, and return on invested capital (ROIC) has risen to 20% from 15%. As we discussed, both metrics appear poised to rise slowly from here, too.
That's great, but our question in Friday's column was "How will PepsiCo continually grow at double-digits?" The main answer provided by the CEO in an article that we linked to on Friday may just be simple enough to work. That is, IF management can get it to work! Pepsi has tried for years to little avail. Here it is:
The answer to steadily increasing growth for a large handful of years -- beyond promotions, new products, and price increases -- is to sell Frito-Lay directly beside Pepsi beverages on the assumption that consumers want both a snack and a drink to go with it. Pepsi dominates the snack food market, so if it can get grocers around the world to marry its drinks beside its snack foods (typically the products share close but separate aisles), then it should sell more of both. This is especially true because Pepsi can easily create side-by-side promotions such as: buy a case of Pepsi, get a discount on Frito-Lay chips ("which, by the way consumer, are at arm's reach!")
Combined, Pepsi's three products (soda, Frito-Lay, and Tropicana) are the second-largest revenue generator at grocery stores, trailing only Kraft products, and Pepsi products are much higher margin (9% compared to an average of 2%) than others for grocers. Therefore, Pepsi has had great pull in getting favorable shelf space for its products. If Pepsi makes more money, grocers make more money. Pepsi is calling its "chip and soda" strategy the "Power of One." But will it result in more sales?
"Power of One" is not enough to base an entire 17-year investment thesis upon it. Combined with Pepsi's other strengths, however, Power of One is just one more strong feather in Pepsi's large cap. As we've said here before: snack foods are an excellent business, and soda is a good business. Combined, Power of One is logical. The strategy should work to degrees. But, will it work towards long-term, continual market-beating earnings growth? Or does it sound far-fetched, like past strategies at Campbell Soup (NYSE: CPB) have proven to be?
What are your thoughts on Pepsi's long-term potential? Is this Drip Port's best choice in the industry? If you haven't yet, please post your thoughts on the Pepsi board. We'll continue from there.
More from The Motley Fool
These Companies Could Benefit the Most From Self-Driving Cars -- and They're Not What You Think
The biggest beneficiaries of hot new tech may be boring old memory makers.
Can Groupon Stock Keep Going After Last Week's 9% Pop?
The leading provider of flash-sale deals moves higher after an analyst upgrade.
Can I Pay My Taxes With a Credit Card?
You can -- but you shouldn't.