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 , Quaker, , 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.

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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 , 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

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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 ‘’. 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 . Beyond Coca-Cola, other important competitors include Campbell Soup Company, Inc, Kraft Heinz, Modelez International, Nestlé S.A and .

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

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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 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.

SodaStream represents an example of PepsiCo’s successful acquisition strategies. It has already been added to Alertsons – the third largest US retailer – and PepsiCo CEO is looking to explore other launch possibilities using his retail network. Although SodaStream stopped releasing its financial results since the acquisition, the company recorded revenues of around $900 million in 2019 according to SodaStream CEO Eyal Shohat. Shohat also expects US market penetration to reach 5% in less than 3 years, which means an additional $1 billion in sales.

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NASDAQ: PEP PepsiCo

E-commerce also provides a strong growth prospect for PepsiCo. With over $2 billion in online sales in 2019, PepsiCo nearly doubled its yearly e-commerce revenue. Having a team of 200 e-commerce professionals continually targeting challenges and opportunities for PepsiCo in the online market, they have been able to launch products early on a number of online grocery platforms. With grocery delivery channels such as Amazon and lowering shipping costs and sharpening the delivery time, e-commerce has become vital in reaching customers in the US market. If PepsiCo’s e-commerce team can continue to exploit its e-commerce network, and launch newly acquired products and already established product lines on these platforms, one would expect a continued growth in 2020. Another key strength of the “Faster, Stronger, Better” model is the aim to become a sustainable business. PepsiCo have announced numerous goals to help limit their environmental impact, including committing to 100% of packaging being recyclable, compostable or biodegradable by 2025. Alongside this they have pledged to achieve 100% renewable energy in their US operations this year, a goal already met in several of their European markets. Furthermore, PepsiCo announced that they are improving water efficiency whilst also delivering safe water to 25 million people by 2025, contributed to the global population. In terms of potential risks, rising commodity costs have been affecting PepsiCo with their cost of sales increasing 2.56% from 2018-2019. Through each business area, the reason for this was partially due to higher commodity costs, alongside increased expenditure on marketing. Although commodity costs are not something PepsiCo can change directly, the “Faster, Stronger, Better” model will allow the company to mitigate the majority of the impact from this. PepsiCo’s plan to utilise technology and optimise manufacturing processes should streamline their processes to allow an offsetting effect to rising cost of sales.

A further consideration when thinking of risks is the changing consumer preferences, particular in the younger generations. PepsiCo has seen a fall in their 18-34 age bracket consumer base due to their movement away from sugary beverages and towards healthier options. However, with PepsiCo’s commitment to adapt to changing consumer preferences their new strategy includes goals to reduce sugars, sodium and saturated fat throughout their portfolio to aid a movement towards healthier products.

Finally, economic headwinds due to the Coronavirus are likely to cause a short-term revenue shock for PepsiCo with consumers’ changing habits. There is also an impact on supply chains with plants being closed in China, and an increasing global impact.

Nevertheless, PepsiCo is in a strong position to continue to see growth in the future with a business model that will allow new growth prospects to be unlocked whilst the company continues to adapt to market trends.

Management Structure & Integrity

PepsiCo have an extremely experienced executive committee. Chairman of the Board since 2019 and CEO since 2018, Ramon Laguarta has been with PepsiCo for 23 years. Under his leadership, the company is also embracing new behaviours encouraging high performance and increasing competitive advantage. Prior to becoming CEO, Laguarta was President of PepsiCo, a role in which he helped decide corporate strategy. Marie Gallagher is the company’s Senior Vice President and Controller, currently leading PepsiCo’s financial transformations as their Chief Accounting Officer. She is another experienced member of the committee, having joined PepsiCo in 2005. Vice Chairman and CFO is Hugh F. Johnston, an employee of PepsiCo since 1987 in a variety of positions including Executive Vice President.

In terms of compensation, PepsiCo’s 2019 Proxy Statement shows that the best-compensated executive is Ramon Laguarta, who received $10.83 million during 2018. CFO Hugh F. Johnston was second to Laguarta with compensation of $9.14 million during 2018.

PepsiCo also actively pursues CSR initiatives, with a core value being environmental sustainability. Their 2018

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NASDAQ: PEP PepsiCo

Sustainability Report illustrates the goals they have set out to achieve in order to become a sustainable business and reduce their impact on the environment, even providing a positive impact, for example replenishing 100% of the water used for manufacturing in high water-risk areas by 2025.

Shareholder Structure

Institutional investors own most PepsiCo shares with Vanguard Group owning 8.3% of outstanding shares. BlackRock and State Street Corp. are the next largest shareholders with 7.7% and 4.7% of shares respectively. 27.1% of PepsiCo shares are company owned, indicating confidence in their business.

Shareholder Structure

Vanguard 8.3% Group BlackRock 7.7% 27.1% State Street 4.7% 1.9% Corp 1.8% Bank of America Wellington Management Other Institutional 48.6% Company Owned

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