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University of St. Andrews Investment Society NASDAQ: PEP PepsiCo St Andrews Investment Society PepsiCo (PEP) 13/03/2020 NASDAQ: PEP This best-in-breed food & beverage conglomerate, through its strategic product developments and acquisitions targeting changing customer Price (12/03/2020) $118.50 demands, provides a stable and secure investment opportunity buoyed Market /Cap (bn) $165.78 by consistent revenue growth and dividend pay-outs whilst also EV (bn) $175.14 demonstrating potential to be a market leader in new products and emerging markets. Consumer Goods & Services Company Overview Price Target $147.74 Investment Horizon 36m PepsiCo is an American food and beverage company with a portfolio comprising of 22 brands, each generating sales of over $1 billion. These 24m performance: brands include Pepsi, Quaker, Gatorade, Tropicana and Frito-Lay. Originally a merger of Pepsi-Cola and Frito-Lay, PepsiCo has grown to become a world leading brand in the food and beverage market. The portfolio is still growing with five acquisitions in the last year, including Be & Cheery. PepsiCo is split into six divisions, each with its own unique history and way of doing business. The company prides itself on a commitment to grow and adapt with changing market trends leading to their new business model of becoming “Faster, Stronger, Better”. Market Data: Incorporated in this model is a drive to become a sustainable brand, a key 52- Week Range 113.59-147.20 consideration for companies with environmental factors becoming more Shares Out. (bn) 1.39 EV/EBITDA 13.77x important to consumers’ interests. Global diversification and balance EV/OpFCF 20.63x across business areas, provides PepsiCo with a position to withstand P/E 26.56x economic impacts, allowing them to achieve regular growth. Div./Yield 2.74% Financial Data: Investment Rationale Revenue (bn) $67.16 Revenue growth 3.87% PepsiCo presents a particularly robust investment opportunity given its EBITDA (bn) $12.72 history of translating stable revenue growth into positive outcomes for EBITDA growth 1.7% shareholders – 2019 marked the 48th consecutive year that the company EBITDA margin 18.94% increased its dividend pay-out. Recently, PepsiCo has demonstrated Leverage: growing appetite for leveraging its strong foundations to capitalize on new Net Debt (bn) $27.89 opportunities that are primed to deliver over an investment horizon of 36 Net Debt/EBITDA 2.19x months. Net Debt/Interest 29.8x The recent financial performance of the group demonstrates the strength of PepsiCo’s core brands, with organic revenue growth of 4.5% for 2019. This performance is driven by strong growth of the company’s most important division, Frito-Lay, which has grown at CAGR 2.5% over the last two years after a concerted effort to increase its advertising presence and optimise supply chain processes, demonstrating the success of PepsiCo’s approach. Page 1 of 6 NASDAQ: PEP PepsiCo This assertive strategy has translated to success with important strategic acquisitions, for instance with Soda Stream, who saw a revenue increase of 20% after PepsiCo’s 2018 acquisition of the Israeli company. Investors therefore have good reason to be confident in PepsiCo’s ability to capitalize on their other recent acquisitions of Be & Cheery and Rockstar, which will help increase the company’s presence in the energy drinks and Chinese snacks markets, respectively. PepsiCo is a consistent performance should instil confidence in investors, and excite them of new growth opportunities the company will look to make the most of. Its success and demonstrated appetite for market leadership makes PepsiCo a strong investment with great prospects in both the short- and long term. Market Position PepsiCo profiles as a best-in-breed company in the food & beverage industry, a market expected to grow at CAGR 8.4% through 2024 even in the face of risks challenging the market (see Growth Prospects & Risks). The company’s operations are diversified both in terms of product offering and geography. PepsiCo’s brands include global staples like Lays, Gatorade, Pepsi, Tropicana and Quakers, and the United States is particularly important, accounting for 58% of net revenue PepsiCo operates through seven reportable segments, which we realigned during the fourth quarter of 2019. The largest of these is FLNA (Frito-Lay North America), which accounted for 32% of net revenue in 2019. This business segment is an important growth driver for the company, as the global snacks market is predicted to grow by 4.1% annually through 2023. Moreover, PepsiCo is aggressively developing its presence in emerging markets, demonstrated for instance by its acquisition of Chinese brand Be & Cheery, one of the largest online snack companies in China. Moreover, their 2018 acquisition of Soda Stream significantly boosted performance in Europe. Net Revenue by Division 4.35% 5.44% 25.43% 17.46% 3.70% 11.28% 32.36% FLNA QFNA PBNA LatAm Europe AMESA APAC Page 2 of 6 NASDAQ: PEP PepsiCo Net Revenue by Country 20.72% 1.93% 1.94% 2.57% 4.22% 57.54% 4.86% 6.24% United States Mexico Russia Canada PepsiCo competes on a range on fronts with businesses that have a similar geographical footprint and product offering. In the beverage division, the most significant of these is the Coca-Cola Company, who accounted for approximately 22% of the US refreshments market by sales. Competition between these two companies has been fierce for more than 50 years, with their rivalry referred to as the ‘Cola Wars’. In light of the rapid growth of the energy drinks sector, PepsiCo’s recent $3.5 billion acquisition of Rockstar is an attempt to narrow the gap with Coca-Cola, who have a distribution agreement with Monster Beverage. Beyond Coca-Cola, other important competitors include Campbell Soup Company, Keurig Dr Pepper Inc, Kraft Heinz, Modelez International, Nestlé S.A and Red Bull. Financial Position PepsiCo has consistently delivered stable growth, with organic revenue growth of 4.5% for 2019 after adjusting for foreign exchange rates. This growth was delivered with positive numbers from all divisions, ranging from more established products to emerging markets. The Frito-Lay segment, which delivers roughly 25% of PepsiCo’s revenue and is therefore crucial to the organization’s performance, grew by 4.5%. AMESA, which covers emerging markets in the Middle East and Africa, also saw growth of 7%, and will look to be bolstered during the investment horizon with strategic acquisitions like that of South Africa-based Pioneer Foods. Moreover, investment in newer business divisions is bearing fruit - Soda Stream, acquired in 2018, saw 20% revenue growth this year. The results delivered by the collective of PepsiCo’s business segments has translated to net profit increasing at compound annual growth rate 14.62% since 2017. PepsiCo has a healthy debt position despite operating free cash flow decreasing by a compound annual rate of - 4.26%, which can largely be attributed to a 12% increase in capital expenditure on advertising and marketing in 2019. Management expects this elevated spending to be the new normal until 2023. However, PepsiCo’s ND/EBITDA ratio of 2.19 is below the peer group average of 3.92, and rising shareholder dividends demonstrate the stability the company offers. PepsiCo’s share price has been steadily increasing with a 52-week range of $113.59 - $147.20, including a 30% rally over the last 12 months before losing momentum due to coronavirus-induced market shock. Yet, earnings Page 3 of 6 NASDAQ: PEP PepsiCo per share is also expected to increase 7% year on year in 2020, and the company raised dividends for the 48th consecutive year. With CFRA recently publishing a target price of $160, investors should be confident that PepsiCo can overcome short-term adversity and deliver strong growth over the investment horizon. PepsiCo - Financial Summary 17A-19A ($m, FYE 31 Dec) FY2017A FY2018A FY2019A CAGR Revenue 63,525 64,661 67,161 2.82% Growth 1.16% 1.79% 3.87% EBITDA 12,645 12,509 12,723 0.21% Margin 19.91% 19.35% 18.94% EBIT 10,276 10,110 10,291 0.05% Margin 16.18% 15.64% 15.32% OpFCF 9,676 9,227 8,491 (4.26)% Margin 15.23% 14.27% 12.64% Net income 4,857 12,515 7,314 14.62% Margin 7.65% 19.35% 10.89% Growth Prospects & Risks PepsiCo showed strong financial results in 2019, and is expecting continued growth in 2020. The business model of “Faster, Stronger, Better” provides a strong foundation of goals upon which growth of the company can occur. The five acquisitions in the past year are an example of PepsiCo’s commitment to become a stronger company with a diversified portfolio of successful brands. Strategic acquisitions have been at the forefront of PepsiCo’s strategy throughout 2018-19, with the pursuit of companies experiencing rapid growth in global markets. In light of current consumer trends, PepsiCo have taken interest in companies providing health products in a sustainable way. For example, during 2018-19 PepsiCo acquired Health Warrior, Cytosport, Bare and SodaStream, which will allow the company to help meet consumers changing dietary needs. Their newest acquisition announcement is the agreement to buy Rockstar Energy in a $3.85 billion deal. This acquisition will allow PepsiCo to strengthen its position in the energy drinks market which it also has a place in with its Mountain Dew brand. With the energy drinks industry expected to grow to $80 billion over the next five years, PepsiCo has positioned itself well to capitalise off this. Prior to this, PepsiCo also acquired Chinese online snack company Be & Cheery. This is another high growth market with the Chinese snack industry expected to grow at CAGR 6.2% through 2018-2023.
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