What PepsiCo Is Doing Right

PepsiCo (PEP -0.41%) posts strong results for Q3 and raises revenue guidance for the year. Motley Fool analyst Asit Sharma analyzes those stories and discusses whether regulatory risk is big enough to dissuade one from investing in mega-cap companies like Amazon (AMZN -1.65%).

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This video was recorded on Oct. 5, 2021.

Chris Hill: It's Tuesday, October 5th. Welcome to Market Foolery. I'm Chris Hill. With me today, Mr. Asit Sharma. Good to see you.

Asit Sharma: Good to see you, Chris. I'm pumped to be here with you on a Tuesday. Tuesday Foolery is the best. [laughs] Don't tell that to the Wednesday people.

Chris Hill: Yeah. Or certainly to Moser on Monday. We'll just keep this between ourselves. No one's actually listening.

Asit Sharma: Just between friends.

Chris Hill: We got some stuff to talk about. We're going to talk mega caps, we've got the latest from consumer goods. But we have to start with the great Facebook (META -10.56%) outage of 2021. Shares of the social network fell five percent on Monday as Facebook, Instagram, and WhatsApp all went dark for six hours. This was also the day after 60 Minutes aired an interview with Frances Haugen, a former product manager at Facebook. This is the whistleblower who provided internal documents to the Wall Street Journal for their reports titled The Facebook Files. I should add that as you and I are talking, Ms. Haugen is across the Potomac River from where I am. She is up on Capitol Hill testifying before some folks from a little group I like to call the United States Senate Committee on Commerce, Science, and Transportation. In terms of the outage, Facebook apologized saying it was due to configuration changes on the backbone routers. Sure. I know so little about technology. They could have just said we accidently kicked a plug out and it took us a while to figure it out. Two parts of this and where do you want to start?

Asit Sharma: Let's start with this outage because I think that it's important to just take a quick look at this. It tells us that even the most redundant of systems are still highly complex in nature. We can get lulled into complacency as consumers by subscribing to services that have 99.999 percent uptime. That doesn't mean that the probability of downtime on a global scale among all the services we subscribe to is zero. It's something we've got to live with. Now, this was a fairly long outage, more than three hours?

Chris Hill: It's the longest outage since 2008.

Asit Sharma: It goes to show you that a platform like Facebook, which has such a phenomenal reach is not immune to the same thing. Chris, I think it does come down to either someone inadvertently tripped over a chord or there is one room, a little room somewhere in that labyrinth of server closets that needed some maintenance. On a more serious note, sure, it's very, very complex to change any server configuration that's going to affect millions of consumers, let alone in the billions. They got three billion customers. This is just the way things are today in a society which relies so heavily on technology.

Chris Hill: I will just add, I talked with a couple of our colleagues, Katie Piper and Jamison Haase and they are two of the people at the Motley Fool who work with Facebook. Ours is a business that works with Facebook to advertise Motley Fool services through Facebook and Instagram and it was interesting in talking with them. I was just trying to get some insight into, for example, has Facebook reached out to them? The answer to that is no, because typically Facebook doesn't do that sort of thing. But in talking to them, it became clear that the ripple effect of what happened yesterday, because I looked at what was happening yesterday in real-time and as someone who spends time on Twitter, it was amusing to see what people were tweeting and the way businesses were tweeting at one another because their Facebook platform was down and their Instagram account was down. There are direct-to-consumer businesses that got hurt yesterday because they rely heavily on Facebook to drive those impulse purchases for anyone who spend time on Facebook. You've probably seen ads served up to you of humorous posters or clothing or whatever and those sales are gone. It will be interesting to see the extent to which direct-to-consumer businesses in this upcoming earnings season mention the outage as having a small material effect. Not unlike how a weather event can affect businesses for just a short amount of time. But that's the outage. I also saw a lot of coverage yesterday of the 60 Minutes' report and people asking the question, is this different? Is these revelations any different from what has come out in the past and will things change? Most people including Kara Swisher said, "I don't think so." I'm paraphrasing her, "I'd like to think that Facebook will make some changes to their algorithm based on these revelations in the Wall Street Journal. But if history is any guide, they're not going to."

Asit Sharma: I would love for things to be different as well, Chris. Facebook has suffered over the years from privacy issues that have concerned its users, consumers. It's struggling now with its current problem, its problem [...] of Instagram, which we know has issues with body positivity among younger kids who use the platform. That's one of the things that's being covered in the Senate testimony today. But it also has a platform that's geared toward monetization. They're also being accused of lifting controls too quickly after the election in the interest of monetization of their platform and letting harmful messages ramp back up, which is being tied to the events on January 6th on Capitol Hill. You have this plethora of images that is the same old with Facebook when it comes down to looking at its core issue. I think the core issue here is that the executives seem to favor monetization more quickly in advance of working out their various issues that I've just mentioned. Now, stock has done very well. Let's flip the switch here and look at this from an investing point of view, stock's done very well since it went public. But I believe that there is a cost to this. At some point you have to pay the piper. The cost for Facebook of all these issues, even if things don't change, Chris, even if Congress does nothing, and I wouldn't bet against the authority of people like Kara Swisher, they know this industry so well, but the cost here is that Facebook, for whatever reason, has traded for a long while at multiples below its peers. Whether you're looking at price to free cash flow, forward earnings, most pricing multiples that you would apply, they trade at a discount to where they should be for such a high-growth platform, high-margin platform. I think part of it is that investors are A, always scared that the other shoe is going to drop, [laughs] and things will be different, that they'll get reined in, and B, investors just lose the savor of investing in this business proposition because look, we're all human beings, we want to feel good about our investments. I personally own shares of Facebook and I don't look down on anyone who does. But I do think there's an opportunity cost for them and that they're losing the goodwill of investors and some investors are staying on the sidelines.

Chris Hill: It will be interesting to see if we see some institutional paring back. I don't know that that has a meaningful effect for everyday investors like you and me, but we'll see. Let's move onto Pepsi because third-quarter profits and revenue came in higher than expected. The company also raised revenue guidance for the full fiscal year. Revenue was up nine percent in the quarter and Pepsi's CFO, Hugh Johnston, said, if people are wondering if the revenue growth in the CPG space is temporary, in our case, it's not, which I find to be a refreshingly bold comment from a CFO.

Chris Hill: Not to disparage CFOs but as a group, there's no real incentive for CFOs to make bold proclamations. By CFO standards, this one was bold.

Asit Sharma: It was a bold statement. We're not used to associating high-single-digit organic revenue growth with multinational consumer goods conglomerates. It just doesn't happen. I remember a couple of years ago being very impressed and writing about this that Pepsi was going to hit maybe five percent organic revenue growth which in this business if you can stay a point or two ahead of inflation, you're doing pretty good. I think Pepsi is feeling pretty good about the changes that CEO Ramon Laguarta has implemented in the short time he has taken over the reins from former CEO Indra Nooyi. He has made them a bit of a, they call it, faster, stronger, better company. He has paired down some non-essential brands and allocated more resources to moving faster, meeting consumers where they want to be met, etc. Yeah, I think they have this working in their favor but also there is an inflationary component to their pricing. 

Ramon Laguarta talked today on the Investor call about Pepsi's own pricing power because its brands are getting stronger. It is offering the consumer more of what the consumer wants. But we can't ignore that their commodity prices are rising as well. There is a component which is rising inflation, forces Pepsi to raise its prices which translates into better revenue growth. I think there is another confidence factor underlying that statement. They pretty much know that they're going to be raising prices again in the coming quarter and that'll translate into a bigger top-line. But we should give Pepsi a lot of credit for the work it's done. Profits are lagging a little behind where they might be just because of all the supply chain problems that COVID brought about last year and have spilled over into this year with the Delta variant. I'm sure you've seen Chris's stories about the container ships that are floating around outside West Coast ports. Still many snack foods in that global configuration but Pepsi's doing a fairly impressive job here today.

Chris Hill: For those who are seeking dividend-paying stocks, next year they become a dividend king. It's something to raise your dividend every year for 25 years. They're at year 49 right now in terms of bumping up that dividend.

Asit Sharma: Yeah. They've had a really nice structural way of looking at their revenue and profits for several years now which is shareholder-friendly first so there's always this capital allocation component. They're going to make sure that they are generating enough free cash flow to service a dividend. Pepsi does take on a lot of debt but it's quite manageable. I don't expect that to change at all. If anything, as revenue continues to grow and some of the work they're doing on their cost structure, the optimization of supply chains and manufacturing, if anything, that will help cash flow even further. They're going to be continuing this dividend and raising it a long time after they become a dividend king, Chris, in my opinion.

Chris Hill: Our email address is [email protected]. Got a question from Josh Mamari who writes, "My question is mainly about Amazon but it applies to similar companies. I've been invested in Amazon since 2010 and bought more along the way. I haven't bought any more shares in the last 2-3 years because I worry these types of companies are ripe for federal inquiries due to antitrust issues. Is it worth evaluating whether or not a company has increased exposure from unprecedented success before investing more money or is it incredibly arrogant and I should just invest more while it continues to dominate the market?" It's a great question. As Josh says, this is a question about Amazon. It could easily be a question about Facebook or Microsoft or Alphabet or Apple for that matter. I will say as someone who is a longtime Amazon shareholder, I do hesitate to look at a stock that's north of $3,000 a share and does have some measure of risk. I don't think it's as big in Amazon's case as others and we can get into that but it is hard to look at Amazon and be like, "Yeah, I want to buy more at this price."

Asit Sharma: In general, it is. It's hard to look at so much appreciation and buy shares, although demonstrably for those who have done that over the years, it's worked out for them. But I think Chris, what you are mentioning and what our listener is mentioning are very similar. In practice, what's happened with these huge tech companies, big tech, is that they have diminished the risks we've associated with them in each of their respective industries. Over the years, they've reached massive scale. They're still growing. Their market capitalizations are still expanding into the trillions now. As they've conquered the risks that might have taken them out when they were smaller, a great question to ask as well, are they potentially monopolistic entities now? I've loved them as stock investments but are they getting too big? What I think the answer to that question here is in the US, let's stick with US for a moment is the risk exists. But as you mentioned with Kara Swisher, will things change? Probably not too soon. We've got a little bit of political dysfunction in this country on the level of representation. If you think about the senate and we've got a lot of grandstanding as well among the senatorial class. Whenever you watch one of these hearings, it seems to be always half for the cameras and half substance. Now, by any objective measures, that's not the way to go about a regulatory action. I've been surprised personally. This is just my take, in years past watching congressman talk to big tech, they seem to want to a demonstration of the devices during the hearings. Now, clearly haven't come prepared with their homework. If you're going to regulate something, you've got to have pretty crisp knowledge on the product, the service, and what you're trying to potentially break apart. I will say though if we move outside of the US, I think that the European Commission has been a little bit more on their game in looking at these issues.

 Finding some of these companies, forcing them to think about their practices. Maybe Europe takes the lead and it is a tangible risk. Is it a risk so far that we really need to pay attention? I don't think so. I think if anything, the effect will be a net positive for shareholders who have made these companies that they will begin to spin off small parts of their businesses when they do feel a lot of heat. That writing finally comes on the wall which is beneficial for shareholders. Suddenly you get shares in the new business that's cleaving off from the parent and you've got the potential for more price appreciation through there. I am going to blame it on the lack of teeth in the current regulatory infrastructure. It's a lot different than we've seen in different periods of US history. For example, when the railroads were regulated, that was a different type of Congress then than we have today. That's just my two cents, Chris but I am really interested to hear your take on this.

Chris Hill: Well, certainly people I've interviewed for Motley Fool Money when this issue has come up, have mentioned, as you did, the European Commission and to the extent that investors should be keeping an eye on something outside the United States. The European Commission is probably more likely to act. I also think back to a conversation I had earlier this year with Brad Stone who covers technology for Bloomberg and has written a couple of books about Amazon. When I asked him about this specific topic, how much of a threat is regulatory action for Amazon? He basically said, and I'm paraphrasing, Amazon is such a complex business that if you sat someone from the United States Senate down and walked them through every part of Amazon's business and how it works, they would probably end up with the conclusion that, "Oh, OK, yeah, this is not some super dominant." It makes sense to look, I shouldn't say it makes sense. I understand the people who look at Amazon just in terms of online retail and say, "Holy cow, this thing is so huge and so dominant, of course, it must be broken up." I get it, if that's just the lens you're looking through, I understand how you come to that conclusion. But when you expand it to be all of retail and you look at how big Walmart is, not that Walmart needs to be broken up but I feel like Amazon is under much less of a threat of regulatory action than other big tech companies are.

Asit Sharma: I would agree with that. My last point just to complement what you said is the amount of capital that we see flowing into challenger ideas is only increasing. Just this morning, I read about a former Amazon executive who's creating a company that's going to challenge UPS and FedEx for third-party shipping. There is still plenty of money in the US flowing into ideas that challenge Big Tech. I think I agree with you. I think Amazon is probably the one where you can make a great case that it doesn't enjoy some permanent advantage. I think the other pillars of Big Tech could bear some more scrutiny.

Chris Hill: Asit Sharma, great talking to you. Thanks for being here.

Asit Sharma: Thanks so much for having me, appreciate it.

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 yourselves stocks based solely on what you hear. That's going to do it for this edition of Market Foolery, this show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. See you tomorrow.