Please ensure Javascript is enabled for purposes of website accessibility

Has Everyone Forgotten About PepsiCo's Crown Jewel?

By Ted Cooper - Feb 25, 2014 at 5:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

While everyone focuses on the negative headlines, the market has forgotten about PepsiCo's hidden treasure.

FritoLay

Source: PepsiCo.com

With all the negative headlines about PepsiCo (PEP 0.98%), you might think the company is getting everything wrong. Indeed, its beverage business has encountered rough times, particularly in the United States. However, with all the talk about the ailing beverage business, it is easy for investors to forget about PepsiCo's crown jewel -- Frito-Lay. The snacks business is firing on all cylinders and provides ample upside for shareholders.

Great business
The snacks business is as good as ever. According to Morningstar, PepsiCo has a 64% salty snacks market share in the U.S., 60% share in Brazil, and 40% worldwide. Pricing power, vast distribution, and economies of scale make the snacks business especially profitable. Frito-Lay North America and Latin American Foods make up 34% of PepsiCo's revenue and contribute 46% of operating profit. By comparison, PepsiCo Americas Beverages accounts for 32% of revenue but only 26% of PepsiCo's profits.

In addition, PepsiCo has proven itself a better company than international snacks powerhouse Mondelez International (MDLZ 2.02%). Mondelez owns such ubiquitous brands as Nabisco, Oreo, Ritz, Philadelphia, Nilla, Premium, Triscuit, Wheat Thins, and the list goes on. Like PepsiCo, Mondelez derives pricing power from its brands and benefits from economies of scale in advertising and distribution.

However, even with a struggling beverage business, PepsiCo remains much more profitable than Mondelez. PepsiCo generates a high-single-digit return on assets -- down from the mid-teens return on assets it earned before it bought several of its bottling partners. Its return on invested capital is also safely in the double digits.

Mondelez, on the other hand, is not nearly as profitable. Its return on assets and return on invested capital reside in the mid-single digits and have worsened since its split with Kraft. This may be why Nelson Peltz -- the activist investor who is pushing PepsiCo to spin off its beverage business -- is joining the Mondelez board intent on improving profitability. Although Mondelez will never be as profitable as PepsiCo, its struggles in the snacks business shine light on PepsiCo's solid execution and ability to prosper while comparable companies struggle.

Bright prospects
Already earning outsized profits, PepsiCo's snacks business is only growing more profitable. Frito-Lay is gaining momentum in the United States; in 2013, volume increased 3%, organic revenue grew 7%, and operating profit increased 6%. The snacks business is growing in emerging markets as well; volume increased 7% in Africa, the Middle East, and Asia during 2013 -- faster than any other snacks segment.

As of now, PepsiCo's revenue is evenly split between snacks and beverages. However, strong snacks growth in emerging markets and sluggish beverage sales may soon tilt the balance in favor of snacks. PepsiCo CEO Indra Nooyi predicts that "two-thirds of [PepsiCo's] revenue growth [will] come from snacks and, from a geographic perspective, about two-thirds of [the company's] revenue growth [will] come from developing and emerging markets." Over time, the revenue mix will be weighted toward the thriving snacks business and will underweight the struggling beverage business.

Even though many of Frito-Lay's products are not especially healthy, the company is not under fire from public health advocates like those targeting sugary beverages. PepsiCo has been diligent in keeping even its unhealthy products within the realm of reasonable nutrition.

For instance, Lay's Barbecue chips contain only 2 grams of sugar and 1.5 grams of saturated fat. This enables PepsiCo to get away with innovations like chocolate-covered Wavy Lays, which debuted last holiday season to generate buzz around the brand. It has also kept legislators and public advocates from targeting the company -- something its beverage business has not been so lucky to avoid.

Bottom line
PepsiCo's beverage business may be in rough times, but its snacks business is in as good of shape as ever. Investors whose focus is on the headlines could miss out on what the company has to offer: a thriving snacks business masked by a struggling beverage business. If the beverage business slows its descent, the market may return its focus to the outstanding snacks business, sending shares soaring.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Pepsico, Inc. Stock Quote
Pepsico, Inc.
PEP
$171.77 (0.98%) $1.66
Mondelez International, Inc. Stock Quote
Mondelez International, Inc.
MDLZ
$63.76 (2.02%) $1.26

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
356%
 
S&P 500 Returns
124%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/29/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.