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Add to MSN Stock List Message Board  Pre-order Jon's new book. Related Resources Find out who owns PepsiCo Check StockScouter's rating on PepsiCo What stocks are top rated? SuperModels Recent articles: • It's not about war, it's about prices, 2/19/2003 • Why an invasion won't save the market, 2/12/2003 • A fool's gold rush? Readers weigh in, 2/5/2003 More... | SuperModels Why Pepsi could really pop Stock in the maker of Fritos, Doritos and Gatorade is well off its highs, for no reason other than marketwide apathy. If you believe America hasn't lost its appetite for soft drinks and salty snacks, dig in. By Jon D. Markman Behold the Frito, the salty snack industrys ambassador to the world. What could be more innocent, more lovely, more convenient, more consistently tasty or more emblematic of American culinary coolness than the golden, curvaceous, spicy corn chip invented in San Antonio during the Great Depression? Everywhere that I traveled in the shadow of war last week -- from Durham, N.C., through Charleston, S.C.; Savannah, Ga. and Orlando, Fla. -- the familiar orange and red foil package manufactured by the Frito-Lay division of PepsiCo
Not many consumer products can make this claim. Even mighty Coca-Cola So how come the company -- also maker of such premier brands as Mountain Dew, Gatorade, Tropicana juices, Lipton tea and Rold Gold pretzels, not to mention the flagship Pepsi line -- has lost its crunch with investors in the past year? Most critiques of the stock market malaise hold that Iraq war threats are holding back stocks of nearly every stripe due to the fear that consumers will withdraw into their shells when the tanks roll. Yet that doesnt seem a likely culprit here. Americans might buy fewer personal computers or dining room sets because theyre scared to go outside. But chow fewer Fritos and chug less Dew? If anything, authorities say, we actually eat more when were freaked out. No, the soggy performance of Pepsi today is emblematic of the larger problem in the market: an expanding aroma of apathy. Yet this is one stock that could come out of the downturn crisply if investors regain their appetite. Better long-term performance than the S&P Like many old-line manufacturing concerns, PepsiCo shares lagged the market benchmark S&P 500 Index ($INX) in the mid- to late-1990s, only to bubble to prominence once the bear market began in 2000. From 1995 to 2000, the broad market rose 220% while Pepsi shares rose just 127%. But from 2000 to April 2002, Pepsi shares rose 48% while the S&P 500 fell 25%. All told, since 1995, PepsiCo shares have doubled the performance of the market, 167% to 85%. PepsiCos serious problems with investors have come more recently, as the stock has tracked the broad market for the first time in the past decade, down roughly 23% in the past eight months. One headline reason: PepsiCos management announced that it would no longer provide earnings guidance, making the firm seem evasive. Additionally, executives acknowledged they probably cant grow earnings from the beverage side of the business more than about 4% a year and would seek the bulk of profit growth -- 8% annually -- from its salty snacks. Is that so bad? Not really. And thats whats so interesting about this story. Throw in expected expense cuts of $800 million over the next three years owing to increased production efficiencies and synergies from its $13.4 billion purchase of Quaker Oats, and management has promised annual earnings gains of about 11%. Results like those would be great for a premium, non-cyclical growth stock that trades at a 40% discount to its five-year average price-to-earnings multiple. But how can Pepsi grow snack revenue 8% when its products are already ubiquitous? That is the key challenge. Consumer-goods companies have an edge in this realm over high-tech manufacturers, as they can use clever research, product development and advertising to breed and encourage new tastes relatively quickly. Figure on seeing 40 new products in the first half of this year, double the number of last year. Pepsi plans to grow the niche, for instance, by focusing on healthier eaters who dont currently buy its products. It will try to sell more of what it calls better for you snacks, such as Baked Doritos that have about a third less fat than the traditional Doritos. Next month, PepsiCo will leverage the natural-foods buzz of its Quaker division to enter the macrosnack segment of the industry, which are products that encourage consumers to replace a meal with a snack. (I just ate a macrosnack instead of breakfast, a SuperProtein bar made by the Odwalla unit of Coca-Cola.) And Pepsi will add new form factors for existing snacks, such as the new Lays Stax brand, which will compete with Pringles for control freaks who like their chips in a neat package. Last years introduction of Go Snacks," 8-inch-tall screw-top canisters for Doritos, Fritos and Cheetos, was a big hit with kids and let the company double their net revenue per pound, according to a J.P. Morgan analysis. On the beverage side, Pepsi has just introduced a lemon-lime soda, called Sierra Mist, that it hopes to make a serious competitor to 7-Up and Sprite with a $50 million ad campaign. And it will leverage Gatorades 85% share in the athletics drink segment by pushing it deeper into more schools, vending machines and unusual distribution points. Importantly, the company has elected to use Gatorade to focus on new ethnic food and beverage opportunities as well; an example is the new Xtremo sub-brand of sport drink, which is aimed at Latino consumers with flavors like Mango and ads in Spanish-language publications. Tropicana is the weak spot in the picture, as Coca-Colas Minute Maid division provides formidable innovation and pricing competition. On the operations front, PepsiCo has created what it calls its 168 Hours plan to run its production facilities around the clock. (Seven days a week times 24 hours a day equals 168 hours.) The company says production efficiencies will help it save $200 million by eliminating the need to add new plants for the next three to five years. That may be bad for the industrial machinery and real estate industries but good for PepsiCo shareholders. Managers say theyll also make the business more efficient by changing the way they chip potatoes to save 50% of their waste, increase warehouse velocity by optimizing their supply chain and improve their selling systems with less expensive displays and other methods to get them into smaller accounts. What are the risks? Of course, there are a few things you can be worried about.
At its analyst day earlier in the month, PepsiCo officials said they were comfortable with earnings of $2.19 a share to $2.23 in fiscal 2003. With a P/E multiple of 20, which is at the low end of its five-year range, the stock ought to be worth $43 to $45 on a valuation basis if the guidance is accurate. Boost the multiple to 25 in the event of spicier investor attitudes, and you can see $55 on the horizon, which was the April 2001 high. You dont need rose-colored glasses to see the company making the lower end of these numbers. Just a little less smoke and fear. For the brave and hungry, its almost snack time. Fine Print For more information on Frito-Lay products, visit this page. One example of a new vector for PepsiCo growth is in the herbally enhanced beverage niche. Its bet there is the SoBe brand, made by the South Beach Beverage Co. of Norwalk, Conn., that features, among other drinks, the dairy-based, fruity Lizard line that appeals to 10-year-old skateboarder/snowboarder/mountain biker types like my son. Read all about it on its cool Web site. ... Not everything works. I tried the new Gatorade Energy Bar last weekend and thought it tasted terrible. No way Id give up my Odwalla bars for that. You may have noticed that small- and medium-sized oil-drilling companies have been on the move lately, with many hitting six-month and one-year highs. The move didnt come out of thin air, as these stocks were picked by our StockScouter tool as the sector to bet on way back in the early fall last year, as noted in my Oct. 2 column, Play both sides of the market to win. My proposed 10-name StockScouter long portfolio -- made up entirely of drillers such as XTO Energy Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at supermodels@jonmark.com. At the time of publication, he owned a position in Patterson-UTI Energy, but positions can change at any time. | ||||||||||||||||
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