Pepsi Indra Nooyi's Pepsi challenge May 29, 2012: 5:00 AM ET Email 38 Print By the numbers, PepsiCo has done a pretty good job since she took the helm six years ago. So why is the CEO taking so much heat from investors? By Geoff Colvin, senior editor-at-large FORTUNE -- "Now tell me again -- what exactly is the issue with this company?" Indra Nooyi asks with an edge to her voice. She has just rattled off a list of statistics describing the financial performance of PepsiCo (PEP), the company she has run since late 2006. They show that it has been growing, earning high profit margins, and paying respectable returns to shareholders through dividends and stock buybacks. So, she wonders, what's the problem? Why on "Performing while transforming": Nooyi in a White Plains, N.Y., Stop & earth has she been taking such an Shop infernal amount of heat from investors, Wall Street analysts, and the media? For she has been, and she clearly resents it. It's a drizzly morning, and Nooyi is aboard a company plane for the 25-minute flight from headquarters in suburban New York City to a Frito-Lay plant in Killingly, Conn. She has been up since 4 a.m., having gone to bed at midnight after watching The Daily Show and The Colbert Report, which she loves. "They say sleep is a gift that God gives you," she observes. "That's one gift I was never given." Definitely not fatigued, she explains how she's been transforming PepsiCo from "a North American fun-for-you company" -- maker of Pepsi, Mountain Dew, Lay's potato chips, Doritos, Cheetos, and hundreds of other foods and drinks -- into a global enterprise with a product line that can prosper in a world where obesity is fast becoming the No. 1 health problem. Making that profound shift, she says repeatedly, is "the right thing" to do. What's more, the company has been "performing while transforming," delivering those financial results she cites. Yet for all that, the conventional wisdom is that she and PepsiCo are in trouble. More: PepsiCo: No. 41 on the Fortune 500 This is the hardest time in any transformation, when the returns haven't arrived and no one knows when or if they will. "The recent past reminds me of pivotal moments in our history when bold leaders made decisions that weren't popular but were the right decisions to position the company for the future," says Steve Reinemund, Nooyi's predecessor as CEO, who until now hasn't spoken publicly about the company's prospects. An example was president Donald Kendall's combining Pepsi-Cola with Frito-Lay in 1965. "Few people saw that as smart," Reinemund says. "Major change is never applauded until your numbers prove it. And they will. I'm confident they will." Are the critics nuts? The most widely repeated case against Nooyi is in fact off-base. It goes like this: The stock has tanked on her watch, shaming PepsiCo in comparison with the eternal enemy, Coca-Cola (KO), which has soared (see "The New Coke"). And she has torpedoed the company's performance by committing far too much time and money to healthy products that make a CEO the darling of the Clinton Global Initiative but that real-world consumers don't want to buy. None of that is true. The stock's total return to shareholders has exactly matched the S&P 500 (SPX) over her tenure. The Coke comparison is invalid; when Nooyi got her job, Coke was just starting to recover from a dismal decade, while PepsiCo stock was richly valued. There's no evidence that a greater focus on good-for-you products -- nearly all of which are in Quaker Foods, Tropicana, and Gatorade, businesses PepsiCo bought long before Nooyi became CEO -- has damaged overall performance. So, as Nooyi defiantly asks, "What's the issue?" Critics who have looked deeper point out that PepsiCo does face significant challenges that have hurt the company. Its all-important return on capital -- economic profit as a percentage of all the money that investors have put into the company -- has plunged. Several of its most valuable brands, such as Pepsi and Doritos, have lost strength or market share, or both. In an industry that survives by exciting consumers with new products, innovation has been weak; the company has introduced flavor tweaks such as Cherry Vanilla Pepsi, for example, but nothing to match Coke's hugely successful Coke Zero and attention-grabbing bottle and can designs. Basic execution -- getting the right products into the right stores in the right quantities all the time -- has been subpar; the company has had trouble holding its share of retailers' floor space. Overhead has ballooned, leaving the company less efficient and productive than it needs to be. Combine those sins, and you get a company with a worrisome future. All the facts Nooyi cites about PepsiCo's performance are correct, but they're measures of the past. Investors care only about what's ahead, and they're not confident. Do the math on today's stock price, and it implies that investors don't expect PepsiCo's economic profit to increase for years; on the contrary, they expect it to decline slowly (see chart above) -- not an endorsement of management. "The management team will have a period of time to execute," says Donald Yacktman, whose Yacktman Fund is the largest non-index-fund holder of PepsiCo stock. "If they don't, you have an above-average bench behind them, and there'll be changes." Nooyi acknowledges that PepsiCo has to change. In a corporate mea culpa before a roomful of Wall Street analysts in February, she and other top executives essentially confessed their sins and outlined a plan to correct them. The company will get leaner by firing 8,700 employees (about 3% of the total), consolidating facilities, and finding other efficiencies, saving about $1.5 billion over the next three years. It will increase advertising and marketing by $500 million to $600 million this year, or about 15%, focusing on a handful of big brands like Pepsi and Doritos in North America. "We don't believe we are delivering enough incremental innovation," Nooyi allowed, and described a plan to introduce more and better new products. The cost of making those changes, combined with expected jumps in the prices of corn, potatoes, aluminum, and fuel will push profits down this year. Then, the company projects, slowly but surely it will finally start raising its return on capital next year. Achieving those goals is no slam-dunk, but the plan is plausible. For PepsiCo's future and Nooyi's legacy, much depends on whether it works. For investors, as CFO Hugh Johnston says, "The question right now is, very simply, 'Show me.'" The stakes are high. Morgan Stanley analyst Dara Mohsenian describes them starkly in his recent report arguing for buying the stock: Either the plan works, in which case "the stock outperforms," or it doesn't work, which "may lead to more drastic action," such as "management changes" or "strategic action" -- Wall Street code for breaking up the company. Either way, the stock goes up -- a "win-win" for investors, he says. But in the second scenario, PepsiCo as we know it, and presumably Nooyi, may be gone. How did it all come to this -- thousands of layoffs, falling profits in a growing economy, analysts speculating on breakups? Nooyi, who joined PepsiCo from the Swiss-Swedish conglomerate ABB (ABB) in 1994 as chief strategist, got the CEO's job because the board wanted the company transformed. She and the directors saw two massive trends that could enrich or threaten the company: globalization and the worldwide rise of lifestyle diseases -- diabetes, coronary artery disease -- influenced by what people consume. "The board put in Indra as, I think, it believed PepsiCo needs to recast itself over a decade or so, and it saw her as a change agent," says John Sicher, publisher of Beverage Digest. "If it stayed mainly a North American snacks and soft-drink business, its days of strong growth were numbered due to limited North American growth potential." On globalization she had to move fast and big. PepsiCo's business relied overwhelmingly on developed markets, especially the U.S., which were mature and growing slowly. The rise of the BRICs was not exactly a secret, and PepsiCo trailed far behind major competitors like Nestlé and Coca-Cola, which had been thoroughly global for decades. So she began buying food and beverage companies in emerging economies worldwide -- Brazil, India, Ukraine, and many others -- A good idea at the time: PepsiCo bought back U.S. bottlers after the culminating in two big Russian outfits, recession, largely to control pricing. The result of that and other acquisitions? Return on capital plunged. the Lebedyansky juice company and Wimm-Bill-Dann, which is mainly a dairy business. That's a lot of buying -- over $7 billion just for the two Russian companies. But "doing it the slow way, organically, would have set us back," says Nooyi. "We had to power forward and then build from there." Responding to the lifestyle-disease trend was at least as urgent. Obesity was moving beyond its role as the West's worst health problem and becoming a concern in emerging markets. For a company that urges billions of people to consume ever more snack foods and soft drinks, that's a problem. Nooyi decided that PepsiCo needed a serious R&D operation to get ahead of the looming threat.