PepsiCo (NASDAQ:PEP) has a long and storied history of rewarding shareholders. The company racks up solid growth year in and year out, and pays a nice dividend to shareholders. PepsiCo's results this year once again prove what a strong business it is, and PepsiCo's growth is measurably better than its close rival Coca-Cola (NYSE:KO).
For these reasons, I bought shares of PepsiCo several months ago. I continue to view PepsiCo as a superior investment to Coca-Cola. However, one pressing issue raised in recent weeks has led me to doubt my investment. PepsiCo is being pressured to split the company into two parts. While I would love to own my shares of PepsiCo forever, splitting up the company would compel me to sell my shares in one of the two remaining businesses.
A diversified business model is why I own PepsiCo
I've written about Coca-Cola and PepsiCo several times, and each of my articles carries a recurring theme. Coca-Cola is a highly profitable company with a world-class brand, which is why many investors, including none other than Warren Buffett, own the stock. However, I believe Coca-Cola's accolades have much more to do with the company's past performance than its future trajectory. I have consistently favored PepsiCo for the past few years because of its strategic vision.
Case volumes of sparkling beverages have flat-lined for several quarters in a row. This is particularly true in developed markets like North America, where consumers are taking real notice of their eating and drinking habits. High-calorie, sugary beverages simply aren't being consumed at the rates they once were, for their reputations as being unhealthy. For example, Coca-Cola's net revenue is down 2% over the first three quarters of 2014, year over year. Meanwhile, global case volumes are up just 2% during this period. While emerging markets are helping to keep sales from falling more significantly, developed economies like the United States still comprise a large portion of Coca-Cola's sales. Revenue in North America is down 1% over the first three quarters.
To be sure, this is definitely affecting PepsiCo as well, only PepsiCo took a much different approach than Coca-Cola. In response to changing consumer preferences, PepsiCo built up its food business. The company owns several brands across categories, including Quaker and Frito-Lay, to the point that PepsiCo's revenue split is virtually 50-50 between food and beverages. By contrast, Coca-Cola has stood still. It's made equity investments in Keurig Green Mountain and Monster Beverage, but those won't be nearly enough to offset soda's decline.
PepsiCo's food business is keeping the company's growth intact, even when it comes to mature economies. Over the first nine months of the year, PepsiCo's beverage business produced flat revenue growth in the Americas. By contrast, its Frito-Lay and Quaker businesses grew revenue by 2% over the first nine months in the Americas. This might not seem like much, but the fact that PepsiCo is still growing in the U.S. in such a difficult environment is a credit to the strength of its diversified portfolio.
Even in the emerging economies, it's the food business that is doing most of the heavy lifting. In Asia, the Middle East, and Africa, PepsiCo grew food volumes by 11% last quarter, but grew beverage volumes by just 3%.
A spinoff would leave investors with a difficult decision
For several months now, pressure has mounted from activist investors like Nelson Peltz for PepsiCo to pursue a spinoff. The rationale for this move is that if PepsiCo let loose its faster-growing food company, it could increase shareholder value by earning a higher valuation multiple than the current combined company does.
However, this would leave investors with a very hard choice. Essentially, instead of one strong company, investors would own shares of a very strong company and a very weak company. There would be little incentive for investors to keep the "bad" company in their portfolios. It stands to reason that the slow-growth beverage stock would carry a far lower valuation multiple as a result.
Because of this, I don't see how shareholders would be better off. If PepsiCo decides to split into two parts, I would sell the beverage company and retain the food company.