Pepsi Is Quietly Having a Very Good Year

In this podcast, Motley Fool senior analyst Asit Sharma discusses:

• Pepsi's ability to increase prices.
• The role of "shrinkflation" in Pepsi's strategy.
• Market reaction to the latest Producer Price Index data.

Did you know Disney tried to make interactive theme parks in the late 1990s? Motley Fool producer Ricky Mulvey talks with Motley Fool contributor Rick Munarriz about DisneyQuest and its potential parallels to the metaverse. 

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on October 12, 2022.

Chris Hill: Don't look now, but Pepsi is quietly having a very good year. Motley Fool money starts now. I'm Chris Hill. Joining me today is Motley Fool Senior Analyst, Asit Sharma. Thanks for being here.

Asit Sharma: Chris. I appreciate you having me.

Chris Hill: Before we get to Pepsi, I want to start with the producer price index data that we got this morning of 0.4 percent, which was higher than expected, causing, at least before the market opened up a little bit of a freak out of, here we go, more inflation, that sort of thing. Tomorrow, Thursday morning, we're going to get the consumer price index. What should we be looking for? Should we be expecting the same thing, or what are you going to be watching tomorrow morning?

Asit Sharma: This is something that Chris is very hard to measure one after another. The reason is the producer price index, that shows you prices that businesses are getting for whatever they're producing, services included. Now, this has an effect on consumer inflation, but it's an indicator of future pricing out in the marketplace. If input costs for businesses are rising, somewhere down the road, you and I are paying more for the stuff that we're buying. The two don't necessarily have an immediate correlation when the reports land up together, some of it will probably be visible. But what this does tell us is that inflation hasn't backed off yet. Producer prices increased 0.4 percent last month. If you look at this on a trailing basis or a twelve-month basis, that's an 8.5 percent gain, a little bit less than the month before, but still pretty high. And what it tells us is that this is a big data point for the Fed. Does it make them more likely to increase interest rates or less likely? I'm going to bet more likely.

Chris Hill: Yeah, I saw a headline this morning that was after the PPI data came out, and this has sparked fears from some investors that the Fed might increase rates again. I thought, who are these investors who are still on, it's like a newsflash. The Fed is going to increase rates again. Everybody can stop wondering, stop fearing whether or not they're going to do it, they're going to do it.

Asit Sharma: That's right. It's like wondering if your parent is going to back off of keeping you grounded when you've been really bad. You're going to be grounded for whatever it is, the week. You're probably not going to get off after a couple of days. We know what the inflation we've experienced in the economy. Chances are more likely through the end of this year, the Fed is in a raising posture. I'm with you man, I'm like, hey, rates are still going to go up. That's the big picture. Then these reports, they have less of an impact on the investor who understands inflation will trail off after some time. Maybe it isn't this month.

Chris Hill: Well, let's get to Pepsi then because Pepsi's third-quarter results came with increased guidance for the rest of the fiscal year. Third-quarter profits and revenue were higher than expected. They didn't put it this way, nor should they put it this way. But my reading of the quarter was because their revenue was up, their volume was down. I read that as, hey, we're selling less stuff, but it's OK because we're charging a lot more for the stuff that we are selling.

Asit Sharma: You read that correct, Chris. That's the takeaway from this report. Now, in a moment, we'll talk about whether that lasts, but let's talk about what's here on the ground. Pepsi has done everything right during the period in which inflation was low, interest rates were low. That is their job in those periods where you and I have a lot of spending power. Their job is to hook us on the right stuff. If you doubt that this is their goal or one of their business strategies, CEO Ramon Laguarta said today, we've seen, I think affordable treats and small moments of pleasure continue to be a key need state. What he means by that is this indulgent category that Pepsi plays in between it's soft drinks, between its Frito-Lay brands.

That intersection that I often talk about on the show in the C-store when you walk in and see Mountain Dew and Pepsi marketed together, the intersection of that space and they're healthy snacks in there as well, they've got many healthy brands, is something that we should be slightly addicted to when we've got spending power. Now, as that spending power decreases in the periods where inflation rises, interest rates rise. If they've done their job correctly, to an extent, we'll pay for those products even as they start to raise prices on us. Pepsi has shown time and again this year, they have pricing power in spades. Now, question I'll pose back to you, do you think this will last? On the call today, there were hints from management that they might be at peak pricing power. Therefore if volumes continued to decrease, they may be hitting an equilibrium point. But so far this year, stock is up today. They've really benefited by this long-term strategy. It's the kind of thing you want to see out of a big consumer goods facing multinational. What are your thoughts about this ability to raise prices and how long it lasts?

Chris Hill: I'll get to that in a second. But since you mentioned the stock, the stock is up almost 5 percent this morning. I know the phrase defensive stocks doesn't really get the average investor excited, particularly younger investors. But it is worth pointing out that with this rise today, shares at Pepsi are basically flat, year-to-date, and year-to-date, the S&P 500 is down 25 percent. Maybe it's not for everyone, but holy cow, Pepsi is demonstrating today why they are one of the best defensive stocks out there.

In terms of whether or not they keep this up, I think that's part of the strength of the business. And Laguarta and his team, their ability to tweak prices and tweak sizes, this is as good an example of shrinkflation as you can see in the consumer goods market, their ability to change the size on certain products, make them a little smaller, keep the price the same. I think they've done a very effective job of this and I think it's smart of them to recognize, where the combination of we're coming out of the summer months when beverages like Gatorade have done really well for us in North America. We're going into the colder months. That combined with we're basically at peak pricing, they're not going to continue to hype prices day in and day-out.

Asit Sharma: I want to add one more thing to that. Pepsi and Coke for that matter, other, their peers, have always made the argument: In low-interest rate environments, low-inflation environments that we stay one to two points ahead of inflation. We're going to grow at a rate one or two points ahead and we're going to give you returns by being more efficient on our bottom line. Pepsi has also done a great job of this. They've cut costs, they've been more efficient with their spends, they've put a lot of technology investment into figuring out how they should price, how they can optimize their supply chains. Investors start to take notice in a time like this that wow, falling inflation, being able to stay one to two points ahead of that didn't look so pretty when interest rates were at one and two percent. But now this proposition looks pretty good and you're telling me that you've got an efficient bottom line, so I see money falling to the net profit line. I see cashflows growing. I'll take that, and I think this is part of that 5 percent we're seeing today is investors realize what all-weather means when the weather's bad.

Chris Hill: While we are coming out of summer, we are early in the football season. You mentioned the Frito-Lay part of the business, and that's history. There have been times when the beverage part of this business has struggled and the snack side of the business has really lifted the overall results or kept them afloat. Football season is just, everybody's getting the snacks. You don't even have to be a football fan. You're just going to get those Frito-Lay snacks.

Asit Sharma: Just the thought of it makes you want to reach for that pack.

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

Asit Sharma: Thank you, Chris. This is a lot of fun. 

Chris Hill: Tell me if this scenario sounds familiar. One of the best known companies on the planet making a huge investment in virtual reality, resulting in a lot of consumers being confused about what it all means. I'm not talking about what Meta Platforms is doing right now, I'm talking about what Disney did in 1998 when it launched a chain of interactive Theme Parks called DisneyQuest. Ricky Mulvey caught up with analyst Rick Munarriz to talk about DisneyQuest and the potential parallels to the metaverse today.

Ricky Mulvey: What was DisneyQuest and why did Michael Eisner launch it?

Rick Munarriz: DisneyQuest initially, there was this whole half of what is now Disney Springs, which was Downtown Disney before that Village Marketplace in Pleasure Island. Pleasure Island was this place that was basically the whole west half of this whole shopping and entertainment district that used to be a bunch of night clubs and comedy clubs and these interactive themed adventures and they just shut it down for whatever reason, that didn't work. But they left all this real estate here and they didn't know what to do with it. There was like a House of Blues Restaurant and a Cirque du Soleil Theater that was going up. But everything between there and the start of the shopping district was pretty much dead. Here they had these big boxes. One of them being where DisneyQuest went up and they needed to fill it up with stores or little restaurants, little things for people to go out there and do stuff.

DisneyQuest popped up, it was five stories, five floors of basically for every kid or every kid at heart to go in there and play in these either high-tech or in some cases low-tech because they also had the retro video games to immerse yourself in experiences that were very loosely themed to Jungle Cruise, Pirates of the Caribbean, Space Mountain, even Alien Encounter, Buzz Lightyear, so Toy Story. There were a lot of things that were lightly themed, but they were ahead of their times in their ways. Some of them were very high-tech experiences using virtual reality, augmented reality, and even some actual rides, practically rides that had a gaming aspect to it. It evolved as they had this space, they wanted to do something about it and also again, this is also the time when we were still in peak Eisner era. Everyone loved Michael Eisner for awhile they did.

Just like every CEO they always like them for a little while and maybe not so much the current regime, but they always had the CEO. They like him, they love him. It's not somebody like Bob Iger or like Walt Disney himself that can leave as well liked as when they got there. But in this case, it was him and Jeffrey Katzenberg that were being considered to take over CEO. When Michael Eisner got the promotion, Katzenberg was upset. He didn't get promoted, so he moved on. Katzenberg became the K in the DreamWorks SKG. With Spielberg and Geffen, they formed this media company. Katzenberg was very instrumental in basically rebirthing Disney's theatrical animated movies back in the early 1990s.

When the whole Little Mermaid and Beauty and the Beast came up, people saw Disney in a new way, that adults can actually go see these theatrical animation films. He just lead that, when he didn't get it, he moved out and then he started this whole arcade, which was GameWorks, which was a lot like DisneyQuest. Maybe not five floors of fun, but definitely a high-tech arcade to show the latest technology. Disney had this place to showcase its technology that was developing for its parks and also ideally to spread it across the country, if not the world, was the initial plan.

Ricky Mulvey: Michael Eisner, he'd taken some cues from competitors, whether it was Busch Gardens for the Animal Kingdom or Universal Studios for what's now Disney Hollywood Studios. There was an element of looking at what the competition was doing. We're going back in time to Florida. You have this five-story box of virtual reality fun. Are people liking it? Is the guest reaction generally positive? Are people confused? I know you went there.

Rick Munarriz: Yeah. I spent a lot of time there. Early on, if you had the highest Disney annual pass, they included access to DisneyQuest. The last couple of years when it was open, they just said, you got to buy admission so I didn't go as often but I still went there. To me it was a great place to go, especially on a rainy day where you just didn't want to be out in the parks because those have been miserable or late at night since DisneyQuest closed at 10:00, 11:00, sometimes midnight. If the parks were closed it gave you another place to go when you didn't want to be necessarily at a club or just hanging out at some very expensive restaurant outside property. That existed there but to me, it was a great place. There was always so much to do. You basically would go in after you basically punched your ticket in, after they scanned you and saw that you had a ticket to come in, you'd hop this elevator and while in this elevator, all screen would turn out and it would be the genie from Aladdin basically giving you a presentation, welcoming you to DisneyQuest.

I don't think it was Robin Williams that voiced the Genie, maybe it did. If not, it was Homer Simpson, Dan Castellaneta or maybe it was even a third person and then they dropped you off in the third floor. So you're right in the middle of it and right away you're seeing that every floor has new adventures. Do you want to create your own roller coaster? Do you want to ride a bumper car shooting basically medicine balls at other bumper cars? Do you want to have virtual swords and get into a fight with computer Vice Villain. A lot of interesting things happening there. Also a bunch of video games that were on set free. You didn't have to pay for anything. It was all included with your admission.

It's almost like getting Retro Arcade 2. It was basically a lot of things to all people. One of the weirdest games and again, I played maybe three times, I didn't really enjoy it too much was based on The Mighty Ducks like the Anaheim hockey team, where you're basically, I think it was like 12 or 15 people would line up and you are basically a pinball machine and you'd be basically just bouncing around whenever a ball came by you to trigger that to happen and you're trying to score points that way. Definitely a very strange place, but also very cool place where if you were bored, there was always something entirely different, yet entirely indoor and enclosed and air conditioned for you to get into.

Ricky Mulvey: Maybe in the new era of Disney, they'd start charging people for the old school arcade games, but not so when you're paying admission. DisneyQuest did not take off. They briefly had a location in Chicago. There were plans for more locations across the country, possibly across the world, so it ultimately did not work out. What mistakes do you think Disney made with DisneyQuest?

Rick Munarriz: Specifically to the roll-out, and with DisneyQuest itself, the original location, the Chicago location, lasted two years and they broke ground on Philadelphia. They had that ready to go. A year after that, it obviously did not happen. That did not open. Between the time that they launched the first DisneyQuest in 1998 and the time that the Philadelphia place should have opened two years later, obviously, they thought different about at least expanding the concept and obviously, they closed the Chicago location within two years, about 2001, two years after that opened it closed down. I think a couple of limitations were, first of all, Disney is great when they're on the home team. If you're at a Disney theme park, you're not going to flinch at paying eight dollars for a churro or four dollars and 50 cents for a small cup of Diet Coke. You're fine doing that just as you are in a movie theater. When you're away, things get a little tricky.

Just as we saw Disney basically close down most of their Disney stores over the past couple of years, outside of a couple of outlets, sometimes they find that their retail brand is strong as it is, when it's stand-alone, it doesn't hold up so well, especially with this high-tech virtual arcade where you have to maintain and be on top of all these augmented virtual reality headsets to take care of and to clean rides to maintain and more importantly when they launched, people were really excited about virtual reality and augmented reality and even though we're feeling that renaissance now, at the time we eventually just tired of it just because there were limitations to what would happen if you put on a headset. Was it blurry? Were some people getting dizzy when they were taking them off? There were a lot of limitations to the process to roll it out in the kind of scale that they wanted to. Though to be fair, the original DisneyQuest the one in Orlando lasted for 19 years.

It did stick around for a long time, but yeah, expanding it, it failed. Also to be fair, I keep saying to be fair as if I have to be fair, but let's be blunt, [laughs] this was a rectangle in the middle of a place where people were used to being visually stimulated. All they saw is almost like a carnival barker saying, hey, come inside this tent, you'll love it. But there was no way to truly get people to experience what was like to build your own roller coaster and then step into a two-seater simulation and spin up, go upside down as often as you wanted, as far as the track you created. There was really a lot of things that it was hard to sell what was inside without showing more of it off and they never really did that. Not that it was going to make a difference, but I think that toward the end they put monitors right by the outside, like small TVs showing you things that were in there. But it was a kind of thing you really had to experience first and I think they just didn't really get that point, especially when it was 20, 30, $40 to get in by the end, it was really hard for people to justify that at the time.

Ricky Mulvey: Tough to see what's going on inside when there's no windows. Let's think about the DisneyQuest experiment and now you see Meta going whole hog into the metaverse today. Do you think there are any parallels with what Zuck's doing and with what Eisner did, or are there too many differences for the comparison to work?

Rick Munarriz: Again, if you go back, anyone that was there at the original DisneyQuest, there was an Aladdin game where you basically went through the whole area and you were basically looking for the genie collecting jewels and you had to put on a headset, which was a lot bulkier, but not too different than what the Oculus is for Meta and the same thing for Ride the Comix, which was a game where you were actually standing on a platform and everyone saw you because you're in an elevated platform, there were barriers, but people from the floor below could see everyone playing this game. Holding a virtual sword that you'd swinging around to try to basically fend off and attack the virtual creatures that were made. Clearly, it's kind of thing where that technology, maybe it was 20 years ahead of its time and maybe not as well developed.

That's similar to what's happening now, but again, hopefully, what happened then, which is basically people just weren't ready for augmented reality. They weren't ready for virtual reality will be different now for Meta. Clearly, it's putting a lot of money into it. The new Oculus headset's coming out and I have Oculus 2. I don't play with it as often as I thought I did when I first got it. I think a lot of people like me you get it because it's the toy that every man child owns and you put it on and it's like, well, OK, what else can I do it this? I do think it's a technology that will take time and obviously the high-cost barrier to just buy the Oculus headset and to begin with much less all the apps that you have to buy if you want to play in the premium experiences will take some time. But yeah, it's definitely similar. It's a company that is trying to be a step ahead of tomorrow. But as Disney proved sometimes, that's not enough.

Ricky Mulvey: Rick Munarriz. Thank you for your time.

Rick Munarriz: Thank you. 

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. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.