stock certainly isn't doing it for the joy of cola.
Instead, the appeal of Pepsi shares is
, Pepsi's snack foods unit. At a time when most food businesses are struggling, Frito is soaring, dominating the salty-snacks category, posting double-digit operating-profit growth and powering Pepsi's profit even as its cola business treads (sugared) water. Pepsi is briefing investors about its plans for Frito-Lay at a meeting Wednesday night and Thursday in Plano, Texas, that may serve as a much-needed catalyst for Pepsi shares, which are down about 20% from their 52-week high of almost 43.
But some analysts are warning that Frito faces a tougher road ahead, as competitors flock to the fast-growing snacking category. They say that to continue its current sales and profit growth, Frito has to do more than just maintain its domination of the chips aisle -- it's got to watch out for competition from other kinds of munchies. A spokeswoman for the Pepsi unit declined to comment on those issues.
No one disputes that Frito is the king of salty snacks -- things like chips, pretzels and popcorn. Thanks to brands like
, it has a 61% share of the salty-snacks market, according to
, or IRI. The next biggest competitor,
Procter & Gamble's
brand, owns just a 6% share. In the third quarter, which ended Sept. 4, Frito's operating profit rose 11% on a sales increase of nearly 7% (parent Pepsi's operating profit rose 4% in the quarter).
But one analyst team is saying Frito's U.S. operations may soon face increased competition from a different quarter.
Warburg Dillon Read
analysts Bryan Spillane and Christopher Jakubik say that
are coming up with new ways to position crackers, which aren't considered part of the salty-snack category, as competition for chips.
And while they say neither company is likely to go head to head with Frito in the snack-food aisle (Keebler already tried, and gave up, selling its salty-snacks unit in 1995), they think crackers will gain ground at the expense of salty snacks. As a result, they expect Frito-Lay's North American sales growth to slow to about 4% annually and operating-income growth to slow to the high single digits. In part because of their projections for slower growth, they cut their rating on Pepsi to hold from strong buy last month and lowered their target EPS growth to 10%. (Warburg has done recent underwriting for Pepsi or a subsidiary.)
"We look at it as a share-of-stomach battle," says Spillane. Pepsi might find a parallel in its drinks business: Though it and
dominate the cola market, that part of the soft drinks market is losing share to beverages like iced teas, fruit drinks and even water -- a business Pepsi and Coke jumped into only within the last few years.
While conceding that there's as yet no evidence of a shift in sales data, the analyst theorizes that stomachs may be more amenable to crackers. "They're being positioned as a snack as opposed to something you'd eat with a piece of cheese," Spillane says of crackers.
brand. The company has introduced resealable stand-up bags, since research has shown bags are more conducive than boxes to mindless munching. Recent IRI data show Keebler is growing at about 18% by volume. Nabisco, meantime, is similarly innovating with its
brand. (Spillane rates both Keebler and Nabisco strong buy, and his firm has done underwriting for both.)
He also notes that Keebler and Nabisco, like Pepsi, have the benefit of direct-store distribution, instead of relying on middlemen. That allows them a greater degree of control in marketing and promotion. While Pepsi's distribution network is still superior, Keebler and Nabisco have a chance to add new packages and displays and move to different parts of the supermarket.
The Coming Crunch?
Source: Information Resources data for year ended July 18.
"There's been some incursion on Pepsi's turf," says Jaine Mehring, food analyst with
Salomon Smith Barney
, noting the increase of J-hooks holding
mix and Keebler's crackers in the chips aisle. She says that while cracker sales are up, it's not clear whether Frito is losing incremental sales. (SSB has done recent underwriting for Keebler and General Mills.)
To be sure, plenty of people disagree with the idea that Frito-Lay will feel any pain at all from a cracker renaissance. "If you're looking for a cracker, you'll eat a cracker, and if you're looking for a chip, you'll eat a chip," says David Goldman, analyst with
Banc of America Securities
, who rates Pepsi shares a strong buy (his firm did underwriting for the
Pepsi Bottling Group
spinoff). He's looking for Frito to maintain 6% to 7% sales growth in the U.S. and faster growth abroad.
Skeptics also note that while Keebler and Nabisco have direct-store distribution, their networks are nothing compared with Frito-Lay's. Pepsi has the added advantage of distributing to gas stations and convenience stores as well as supermarkets, where much of the impulse snack-buying takes place.
"Is it going to hurt Frito? I don't believe so," says Tim Ghriskey, a senior portfolio manager at
. (Dreyfus owned more than 7 million Pepsi shares as of June 30, according to data tracker
First Call/Thomson Financial
Ghriskey also says that as Americans go from three meals a day to one or two meals supplemented by packaged snack foods, there's room for plenty of companies to boost sales. "American consumers have shown an amazing ability to eat more of this stuff," agrees Salomon Smith Barney's Mehring.
But the Warburg team isn't alone in its concern about Frito-Lay's growth prospects. Salomon's beverage analyst Jennifer Solomon said in an Oct. 11 research note that Frito-Lay North America's performance in 1999 is being helped by lower commodity prices, which boosted margins and freed up cash for promotional spending. That kind of savings won't likely happen in 2000, she says. Greater productivity will help, but investors want to see more than that, she says. "The most important issue from Frito is, how do you grow the top line?" she says. "It's hard to gain much more share." (She rates Pepsi shares an outperform and her firm has done recent underwriting for the company.)
Solomon expects to hear more about new product initiatives, a potential source of top-line growth, at the meeting this week. She's also hoping to hear more about Frito's opportunities internationally, where she says the company is looking for acquisitions. (A Frito spokeswoman wouldn't provide details on new products or what the meeting will address.)
However Pepsi plans to grow Frito-Lay sales, it's as clear as the ill-fated
that with cola sales stagnant, the fate of its share price is increasingly tied to the fate of Frito-Lay. And that means, if some analysts are right, that Pepsi's new biggest competition may come from some elf in the cracker aisle, not its old enemy in Atlanta.