Easy Money: How PepsiCo Can Grow Earnings by 15%

In this episode of MarketFoolery, Chris Hill and Bill Mann give us some insights on how the coronavirus is weighing down companies. Alibaba's (BABA 0.64%) stock, for one, fell despite strong earnings. Meanwhile, Tesla (NASDAQ: TSLA) is raising money in a stock offering, and PepsiCo (PEP -0.41%) is trying to be more consumer-centric and locally relevant.

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This video was recorded on Feb. 13, 2020.

Chris Hill: It's Thursday, Feb. 13. Welcome to MarketFoolery. I'm Chris Hill. With me in studio, the one and only Bill Mann. Thanks for being here.

Bill Mann: Hey, Chris, how are you?

Hill: I'm doing all right. We're going to get to Tesla, don't worry.

Mann: We've got some great stuff to talk about today.

Hill: We've got some stuff to talk about, including Pepsi, which has been quietly killing it over the past year. But we're going to start with Alibaba, because Alibaba's -- help me understand this: Their third-quarter results were better than expected; their cloud revenue is growing; when we walked in the studio the stock was down a couple of percentage points. We'll get to the stock in a second. Just in terms of the quarter, what stood out to you with Alibaba?

Mann: Well, a company that large turning in earnings that are up 38%, I mean, that's amazing. If you just think about the quadratic function of earnings, like, it's just going up just a little bit, it's really hard to generate that type of earnings growth off a base that's that big. So 38%, $23 billion in revenues for the quarter; $7.1 billion in net income. I mean, that's amazing.

Hill: It really is. The stock, over the past year, is up about 30%. Is what we're seeing today a little bit of the valuation, and maybe throw in just sort of the general market sentiments that the news over the past 24 hours with regard to coronavirus is not moving in the direction that it had been over, maybe, the previous 48, 72 hours?

Mann: Yeah. First of all, you're crazy if you believe those numbers that come out of the Chinese government regarding the -- [laughs]

Hill: It doesn't help. It really doesn't help.

Mann: Yeah. So, that being said. That will be the most conspiratorial I'll be in this particular recording. Yeah, they came out and they said that really things are being impacted throughout the Chinese economy. And the means of production, the means of transportation, workers can't get to work. Even if they're there, the supply chain is completely messed up. They are having huge issues. So for a company like Alibaba that basically sells products and services online, they are seeing a huge impact. Maybe not as bad as other companies, because they do control some of their means of production and really a lot of their means of transportation and distribution. But it is still a big deal for a company that has so much of its earnings coming from one place, for that place to literally be on lockdown.

Hill: So we are in the back third or so of earnings season. And as expected, over the last few weeks we've seen large companies come out on the conference call or just in the report that they issue, refer to China, the extent to which they're doing business in China, the impact of coronavirus and a lot of companies have been, I think, on balance as transparent as they can be, working with the information that they have. And so we've seen a lot of, "Well, we've budgeted... " just to pick Disney as an example -- when they talked about the impact on the parks in China, they budgeted it for two months. If we're closed for two months, this is what the impact is going to be.

We are coming to the end of the natural cycle of companies giving us information, and I don't want to say I'm concerned at this point, but I'm certainly on watch at this point for the next cycle that we enter into, which is, we're passed earnings season, and as this drags on, I think we're going to see more companies -- Alibaba among them -- coming out and saying, "Remember that thing we said when we came out with our quarterly report?"

Mann: "We were serious." [laughs]

Hill: "We were serious and we have an update, and here's the new update." I mean, it just seems like the longer this drags on, the worse the ripple effect could be.

Mann: Well, it's not even just that. Also keep in mind, yeah, we are toward the tail end of earnings, but Alibaba is actually the first big e-commerce company in China to report. So we are just at the beginning of that information cycle. I mean, we're going to hear from some of their competitors. We're going to hear from JD.com; we're going to hear from Tencent. That's all coming up. So they are the ones who are really giving us the first look into what's happening in China from a company that's really, really dependent not just on supply, but also on demand in China.

Yeah, it's really, it's hitting a bunch of companies, and it's not just where they are doing business. So, like, for example, I'm going to give you a data set of one. My mom was trying to get a new iPhone and they didn't have any in stock in the store nearby, because China production has got everything on back order. These things are happening in ways that we really can't just see yet. It'll be interesting to see.

The company that I'm most interested in, in China, is actually JD.com, which is probably a tenth the size of Alibaba, but JD.com has spent billions of dollars in setting up their own logistics network. And I really can't wait to see from them where we'll start to see the breakdown between logistics and production in the country when they report here coming up.

Hill: Two weeks ago, Tesla had their quarterly conference call. Elon Musk was asked if the company planned to raise more money. And he said no, but that was two weeks ago, right?

Mann: I mean, that's a year in Tesla time.

Hill: It was two weeks ago; it was also more than $100 a share ago. This morning, Tesla announced plans to raise $2 billion in a stock offering. What was your reaction when you heard the news?

Mann: This makes me so happy to see. It really does. I think Tesla should try and raise 10 times this amount.

Hill: I was going to say, one of the comments I heard this morning was, "Why stop at $2 billion?"

Mann: Raise the money, right. Tom Gardner and I've had long debates on Tesla, and I've always described Tesla as a mutant company; like, you know, you throw all the statistics out the window. And Tom has been much more bullish on Tesla, which means he's been much more right on Tesla than me. I've disagreed somewhat, but I have agreed -- like, Tom and I both agree that we hope he's right. Like, I don't want to be right. I want Tesla to be a monster.

So the reality is that Tesla is a manufacturing company, and it's trading currently at about five times sales, which, for a company that costs that much for production, is pretty expensive. It has nothing on, like, Shopify, which is 44 times revenues, something crazy. But they really, really, really need money to produce, to grow into the market cap that they have. So I really would have grabbed that with both hands. I'm happy to see this. People forget about share prices having this reflexive prospect, where the fact that the stock has gone up so much makes the bear case for Tesla that much worse, because they have access to money. So, very happy to see it.

Hill: Well, one more reason to not stop at $2 billion is, among other things, they announced -- sort of, to reiterate it, like, "Yeah, we're going to be spending more on capex." So raise even more. [laughs]

Mann: Yeah. Right, exactly. I mean the capex comes in a couple forms. It comes in production. It comes in purchase of raw materials -- especially lithium for the batteries, which has always been an area where I have wondered where the inflection point is on, both on pricing and on supply. But also, on the back end, I mean, they are literally bootstrapping a service network, they are bootstrapping customer support. Like, spend the money. Go get that bread. [laughs] I'm happy to see it. I really am.

Hill: By the way, I was reminded this morning that Larry Ellison, the longtime CEO of Oracle, is on the board at Tesla. Wouldn't you like to just -- I don't know, I feel like a boardroom conversation, just between the two of them. I'd pay money to listen to that.

Mann: Oh, my gosh! Who is righter in that? [laughs] I mean, one of them is 115% right and the other is 120% right.

Hill: Let's talk about Pepsi. Wrapped up the fiscal year with a strong fourth quarter. Profits and revenue came in higher than expected. Their international growth, their organic growth internationally is pretty impressive.

Mann: Which is funny, because there's not much about Pepsi's products that is organic.

Hill: [laughs] Right. Exactly.

Mann: So I've paid attention to Pepsi from time to time, but this just shocked me. Can you guess their market cap?

Hill: Oh, gosh... $140 billion.

Mann: $202 billion. And Pepsi, you generally think of, because it's called Pepsi, as being the strong No. 2 brand in sugar beverages to Coca-Cola, which has been a really, really hard market to be in. One, because people's consumption habits have changed. But two, it's really competitive -- not just Coke, but all of the upstart brands that have taken share. But Pepsi has done a great job focusing on Lay's and on Doritos and trying to become more consumer-centric, becoming more locally relevant. So yeah, the company is actually quietly firing on all cylinders.

Hill: It's interesting also because for a very long time there were debates within Pepsi, not just about, "Hey, we should spin off the snack division. We should unlock value by spinning off Frito-Lay." There was that debate, but there was also a debate just within the beverage division about the number of brands they have. "Do we have too many?" "Should we spin some of them off?" And to me, this latest quarter, just on the beverage side, is a great example of a diversified portfolio. It's not a portfolio of stocks; it's a portfolio of brands. And so in the case of Pepsi, when Mountain Dew sales are stagnant, as they have been, they're able to ramp up what they're doing with seltzer, with their bubbly brand, and that sort of thing. And you know, everything we say about you need to have a diversified portfolio, you need to have 15 to 20 stocks, that kind of thing -- that's playing out with beverages for Pepsi.

Mann: Yeah, and if you think about grocery stores, it's basically a real-estate game when you're looking to get shelf space. And so what Pepsi and Coke and Doritos; pick your poison -- excuse me, I don't mean to say pick your poison. Let's go back.

Hill: How dare you refer to Doritos as poison?

Mann: Select your example, and you'll see that they rotate the brands and the brand iteration so quickly to try and get as much of that space -- as much of that eye-level space -- as possible. So you see the off-brand flavorings of Pepsi. And again, as you say, the water, the Mountain Dew, and they're innovating, one, to keep up with consumer taste, but two, just get as much of that shelf space as they possibly can for themselves.

Hill: Do you have a particular snack, whether it's a Frito-Lay snack or others that is -- I'll just speak for myself -- that in a moment of weakness, you say, "Ah! I'm getting a bag of these." For me, it's Cheetos. [laughs] It's a moment of weakness. I'm like, just -- I don't make it a regular habit, but I need these.

Mann: I can crush Cheetos, but you know what?! Actually, I do have a plan which will help Pepsi grow its earnings by a minimum of 15% next year.

Hill: Do tell.

Mann: So, Doritos, a couple of years ago put out in Canada, Venezuela -- places where we are not -- a type of Doritos called the roulette Doritos, Doritos Roulette. Have you heard of this?

Hill: No. I'm intrigued.

Mann: So it's Nacho Cheese Doritos, but one out of every six chips was violently hot.

Hill: Oh, really?

Mann: Yes. Why didn't we get this?

Hill: Why indeed?

Mann: [laughs] I'm just saying that they have in their back pocket the plan. I mean, the amount of games that come just from a bag of -- I mean, they can even take some of that action if they want. I'm just saying, Pepsi, please, Frito-Lay, please, bring Doritos Roulette to the United States of America. We will do great things with this.

Hill: Well! And particularly since -- again, to go back to their fourth quarter, their North American organic sales, they were good. They weren't what they were in other parts of the world. So come on!

Mann: No. And they've just said that they want to be more local and consumer-centric. What better? What better thing than to play to our enjoyment of spicy food and surprises and gambling? [laughs]

Hill: It's really the gambling that makes it --

Mann: Obviously, I wanted to end with that, but let's start with that.

Hill: No, no, no, we'll end there. Bill Mann, thanks for being here.

Mann: Thanks, Chris.

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for today's MarketFoolery. The market is closed on Monday, so we will be back on Tuesday. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you on Tuesday.