has drawn plenty of eyeballs on behalf of Pepsi Cola in her latest spokeswriggling gig, but
soft drinks aren't what's attracting investors to the company. They're fixated on its monster-sized snack business,
, which continues to eat up market share in its category, and on promising gains in snack and drink sales overseas, where Pepsi has traditionally lagged arch-rival
All in all, Pepsi's diverse lines of snack foods and juices appear poised for a stretch of strong, stable growth after an unsightly restructuring that dragged on in the late '90s. With the pending acquisition of
, the makers of brands like Cap'n Crunch, Aunt Jemima and the number-one selling sports drink, Gatorade, Pepsi has slightly upped its long-term earnings per share growth rate, projecting a five-year compound annual growth rate of 13% to 14%.
, Pepsi's generous 30.1% return on equity -- a measure of how much profit a company earns as a percentage of stockholders' investment -- lands it in the top 5% of all U.S. companies.
Plus, the stock's valuation is still reasonable, though it's up 16.7% over the past year. Pepsi recently traded at $42.27, off its 52-week high of $49.94 in December. It sells for a P/E multiple of 29, compared with Coke's multiple of 52.
Cheetos: A Port in Any Storm
It remains to be seen how much Pepsi could be hurt by a downturn, but analysts generally consider sales of soft drinks and snacks to be resilient because the products don't cost much. "I don't think world economic growth affects people's purchase of soft drinks. They're not high-ticket items," says John Kornitzer, president of Kornitzer Capital and a strategist for the
Buffalo Equity fund.
If it's any indication of how well revenues could hold up, Pepsi's cola and fruit juice sales have looked sturdy over the past few months, and Frito-Lay (which owns Cheetos, Doritos and Ruffles) recently wrapped up a 12-week period of stellar sales growth. For the period ending March 24, Frito-Lay sales grew 9.1%, the fastest pace in four years of data from
, the market research firm. Those gains come on top of pricing benefits stemming from Frito-Lay's so-called "weight-out" strategy of putting fewer snacks in each bag, allowing it to make more money without having to raise prices.
Pepsi Pro Forma Net Sales
Source: PepsiCo 2000 Annual Report
Pepsi Operating Profit
Source: PepsiCo 2000 Annual Report
While soft drinks are the best-known business at PepsiCo, Frito-Lay is easily the biggest money maker and most investors see it as the primary reason to own Pepsi , despite Britney's writhing testimonials to cola. Last year, Frito-Lay kicked in 66% of operating profits. "The key issue is that Pepsi's not simply soft drinks. The underlying attractiveness is Frito-Lay, the number-one snack food franchise in the world," says Gary Dunn, portfolio manager for the
Wells Fargo Equity Income fund.
The soft drink business itself is mature and growing very slowly. The volume of Pepsi-Cola sold in the U.S. measured in cases was actually down 1%, according to John Sicher, editor of
, a trade magazine. Pepsi's overall soft drink business, including faster-growing brands like Mountain Dew, Diet Mountain Dew and Wild Cherry Pepsi, performed slightly better, up 0.1%.
"The cola business in general has been underperforming the overall carbonated soft drink business for a long time," says Sicher. Last year growth for Pepsi-Cola and Coke took a hit when both companies raised prices. "But they're now stepping up
marketing efforts behind the big cola brands to try to get more robust performance from those brands," he says.
Even if momentum picks up, sales of carbonated soft drinks will remain relatively weak. As pricing increases moderate, Sicher expects U.S. volume growth in that area to return to around 1.5% or 2% over the next few years, after dropping to an anemic 0.2% in 2000.
Overseas markets offer the potential for more growth. Already, over a third of revenues come from outside North America, and those markets are growing much faster than at home. Operating profits grew 19% for Frito-Lay International and 37% for the soft drinks line, Pepsi Cola International. PepsiCo claims its international soft drink sales grew faster than Coke's in nine of the last 10 quarters, helping it gain market share in most of the biggest 25 foreign markets.
Pepsi Snags Gatorade
And money managers are bullish on Pepsi's $13 billion acquisition of Quaker Oats, expected to close sometime in the second quarter. In the wake of that deal, Pepsi will own Gatorade, the sports drink juggernaut that generated $1.7 billion in sales last year. While soft drink sales are expected to continue creeping along at 2% to 3% a year, Pepsi thinks Gatorade could grow at over 9%, according to a report from
Credit Suisse First Boston
The company also plans to save around $150 million as it integrates Quaker into its own business lines over the next five years by buying materials like plastic and cartons in bulk and trimming administrative expenses.
Plus, with more powerful brands from Quaker in its arsenal, Pepsi will have greater leverage with supermarkets and other retail customers. As it is, chains tend to look favorably on the company's snack foods. They're easy to stock, since in most cases PepsiCo employees come into stores and shelve the goods themselves. But more importantly, snacks offer healthy profit margins for store owners. "Retail groceries have pretty minimal retail spreads, the margins aren't that great. So if you can augment
the groceries with those types of products, all the better," says Wells Fargo's Dunn. Soon, Pepsi will be able to bundle in Quaker Oats' lines of rice cakes and granola bars with its own snacks.
Of course, there are risks stemming from the acquisition, too. As Morningstar notes, half of Quaker's revenues come from its stagnant cereal business, which eked out less than 1% growth last year. That could be a drag on profits.
And complications are bound to arise whenever two big companies merge their businesses. "If the synergies and cost savings don't pan out, that could be somewhat disappointing," says Dunn. "But that sure doesn't appear to be the situation."
One other change worth noting: On the heels of the acquisition, after close to five years with the company, Pepsi's CEO will retire. Roger Enrico, who engineered Pepsi's turnaround over the past few years, will be replaced by current president Steve Reinemund. But Reinemund will take up the job having already established impressive management credentials. A 17-year veteran of the company, he's considered to be a leading force behind Frito-Lay's big market share gains in recent years.