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Senior Project Analyst Report
1. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Additional Disclosures at the end of the Appendix section of the report.
PEPSICO, INC (NYSE: PEP)
SECTOR: CONSUMER STAPLES
DATE: 5/2/2014
EPS(net) 2012 2013 2014
Est
2015
Est
Quarter 1 $0.71 $0.69 $0.79 $0.85
Quarter 2 $0.94 $1.28 $1.25 $1.36
Quarter 3 $1.21 $1.24 $1.35 $1.40
Quarter 4 $1.06 $1.12 $1.30 $1.28
Fiscal Year $3.92 $4.32 $4.69 $4.89
P/E 17.3x 19.2x 18.67x 19.4x
Company Rating
Sector Rating
Risk
HOLD
FAIR
MEDIUM
Recommendation Hold
Industry Food/Beverages
Current Price $85.52
2014 Price Target $87.57
Company Historical Initiating Coverage on PepsiCo, Inc. at the current market price of $85.52 as of 5/2/2014.
Highlights:
1. We issue a Hold recommendation with a target Price of $87.57.
2. Solid 2013 year earnings meeting all financial targets with increase in cash flow,
organic revenue growth and productivity savings.
3. We expect strong top line sales for 2014, and with continual sales growth in the range
of 0.3% to 9.6% for years 2015 to 2024.
4. Increasing growth potential in emerging markets and consistent buybacks and
dividends produce great financial position as well as growth opportunities.
Main Driver
Strength in emerging markets, with increased investment and penetration allows PepsiCo to
build strong brand and growth opportunities.
Main Risk
Weak and shrinking sales in carbonated soft drinks sector. Ability to adapt and hedge against the
changing taste in carbonated soft drinks is questionable.
Future Goals
Focusing core business strategy on emerging markets growth, cost cutting and providing
innovative healthy product offerings.
Sales
Strong sales in Frito Lay snacks business both in developed and developing markets. Relatively
flat sales in global beverage due to the continuation of weak sales in North America beverages.
EPS Growth
PepsiCo’s current EPS growth is based on Frito Lay snacks business unit, developing markets
strength, increasing dividends, and share buybacks.
52 week range $77.01-$87.06
Avg. Volume 5.44M
Market Cap $129.67B
Shares Outstanding 1.52B
Dividend Yield 3.01%
Valuation(range) Monte Carlo Sim
Cost of Equity 3.82 – 9.93%
Beta 0.59 – 0.74%
Risk Premium 2.45 – 9.55%
Risk Free Rate 0.13 – 3.74%
Terminal Growth 1.00 – 1.25%
Projected Avg.
Sales Revenue
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
B = Billion
68.9B
72.7B
76.6B
80.7B
85.0B
89.6B
94.4B
99.5B
104.8B
110.4B
2. Company Profile
PepsiCo Inc.
HQ Purchase, NY
Primary
Industry
Snacks &
Beverages
CEO Indra Nooyi
Exhibit 1: Sales Revenue in Products and
Geographies
Exhibit 2: Sales Revenue & Growth %
Breakdown
Business Description:
PepsiCo, Inc. is a leading company within the consumer staples sector that produces and sells food,
snacks, and beverages on a global basis. In 2012, PepsiCo owned 22 brands that each generated $ 1
Billion or more in annual retail sales. Some of company’s signature snack brands include: Lay’s
Ruffles, Doritos, Cheetos, Quaker Oatmeal; its beverage portfolio includes Pepsi, 7up, Mountain
Dew, Tropicana, Aquafina, and other beverage products.
As of 2013, the food snacks portfolio generates 52% of the company revenue, while the other 48% is
generated by its beverages portfolio. Snacks business generates 66% of growth in company while
beverages generate 33% growth. U.S. and other developed markets account for 65% of sales while
the developing/emerging markets account for 35%. In terms of growth, 66% is generated by
developing/emerging markets and 33% is in developed markets. Company is evenly split with 51%
of net revenue coming from outside U.S. and 49% within U.S.
Sales Performance: PepsiCo consists of 3 business units with six global segments: PepsiCo
Americas Food (PAF) which includes Frito Lay North America (FLNA), Quaker Foods North
America (QFNA), and Latin America Foods (LAF); PepsiCo Beverages America (PAB) which
includes all of its businesses in Europe and Asia, Middle East, and Africa (AMEA). In 2012, net
revenues were represented by the following in percentage, PepsiCo Americas Food (PAF) 37%,
PepsiCo Beverages America (PAB) 33%, PepsiCo Europe 20%, and PepsiCo AMEA 10%. The
following is a chart in terms of sales performance of 2012 FY vs 2013 FY in segments. We continue
to see strong growth in the foods/snacks business and markets outside of U.S. especially Latin
America and AMEA(Asia, Middle East, and Africa) markets, while the beverages continues to shrink
due to its weakening sales in the carbonated soft drinks business (CSD).
Organic Revenue Growth within Global Segments
FY 2012 FY 2013
PepsiCo Americas Food 7% 7%
Frito Lay North America 4% 4%
Latin America Foods 14% 13%
Quaker Foods North
America
1% -0.5%
PepsiCo Beverages 1.5% -1%
Europe 4% 3.5%
Asia, Middle East, &
Africa
10% 11%
Overall 5% 4%
Sales Revenue within Global Segments
FY 2011 FY 2012 FY 2013
Frito Lay North
America
$13.32B $13.57B $14.12B
Latin America
Foods
$7.15B $7.78B $8.35B
Quaker Foods
North America
$2.65B $2.63B $2.61B
PepsiCo Beverages $22.41 B $21.40B $21.06B
Europe $13.56B $13.44B $13.75B
Asia, Middle East,
& Africa
$7.39B $6.65B $6.50B
Overall $66.50B $65.49B $66.41B
3. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Exhibit 3: Three Different Brand images
Fun-For-You
Better-For-You
Good- For – You
Exhibit 4: PepsiCo Products Globally
Company Strategy:
I. Brand Restructuring – build healthy brand image
PepsiCo played its brand strategy as its forefront in catering to the global changing trend of health
aware consumers by creating new innovative products as well as brand restructuring. Its brands are
segmented into three different brand images: Fun- for- You, Better- for – you, and Good – for –
you.The Fun – for – you brand includes treats and snacks that are beloved and are core of PepsiCo.
Its Better-for – you brands are low fat snacks, whole grains snacks, beverages with fewer or zero
calories and less added sugar. It’s Good- for- You portfolio is comprised of nutritious foods and
beverages, products with fruits, vegetables, low fat dairy, nuts, seeds and nutrients with levels of
sodium, sugar, and saturated fat in line with dietary recommendations.
II. Emerging and Developing Markets Growth Potential – grow market share
PepsiCo has continued its aggressive investments in emerging and developing markets. As of 2012,
PepsiCo was #1 food and beverage business in Russia, India, and Middle East. And #2 food and
beverage business in Mexico, and top 5 food and beverage businesses in Brazil, Turkey and many
other markets. Latin America delivered 13% organic revenue growth, with net revenue increased by
7% in 2013.
In January 2014, PepsiCo announced its plans to spend $5 billion in the next 5 years in Mexico
toward brand building, expanding products, production capacity and infrastructure. AMEA (Asia,
Middle East, Africa) has delivered great growth as well, in 2012 and 2013; organic revenue grew by
10% and 11% respectively, with PepsiCo making deals with Suntory Holdings Limited and Tingyi
Asahi Beverages Holding Co. Ltd, opening doors to efficient bottle refranchising and distribution in
Vietnam and China markets. On Feb 27, 2014, Shanghai Disney Resort announced a multi-year
strategic alliance with PepsiCo, Inc. and Tingyi Holding corp. which recognized PepsiCo and Tingyi
Holding as the primary beverage suppliers to the resort. Moreover, in Nov 2013, PepsiCo announced
that it will invest $5.2 billion in India by 2020 to increase its manufacturing capacity and innovation
of products.
In detail, PepsiCo has created new products to its portfolio catering to regional preference and taste.
For example, in 2012 and 2013, PepsiCo added Gatorade grapefruit drink, Lipton milk tea, Mirinda
plum and peach flavors, and also Sha La Cui, a new chip product that tastes like baked salad, all
catered toward the Chinese market. PepsiCo in 2014 will continue to innovate new products and
increase its diversified portfolio to cater to the changing international taste.
Global Sales Revenue Comparison
Sales Revenue FY 2012 FY2013
United States 33.34B 33.62B
Russia 4.86B 4.90B
Mexico 3.95B 4.30B
Canada 3.29B 3.19B
United Kingdom 2.10B 2.11B
Brazil 1.86B 1.83B
All Other Countries 16.07B 16.38B
Total 65.49B 66.41B
4. Exhibit 5: Net Change in Cash Graph
Exhibit 6: Dividend Payout Ratio Graph
Exhibit 7: Common Shares Outstanding
Industry Leaders Comparison
REV MCAP NOI
PepsiCo,
Inc.
66.4B 132.1B 6.7B
The Coca
Cola
Company
46.8B 179.6B 8.5B
Dr.
Pepper
5.9B 11.1B 624M
REV = Sales Revenue
MCAP = Market Capitalization
NOI = Net Income
III. Cash Flow, dividends, share buybacks – creating shareholder value -
PepsiCo is a company that values its shareholders immensely. It prides itself in creating value for the
shareholder by increasing cash flow, growing dividends and repurchasing share buybacks from year
to year. PepsiCo increased in 10 percent in 2013 to $8.2 billion and expects free cash flow to about
$10 billion in 2014. Of the last 20 years, only four of the years, the company came in with negative
net change in cash flow. The good cash flow generated from operations, investing and finance allows
the company to invest in long term capital and make big investments. The company is also strongly
committed in increasing dividend payout and share repurchases, consistently high levels.
Management: PepsiCo, Inc. currently has 30 executive officers on its core leadership management
team. Management team is led by the company’s Chairman & Chief Executive Officer, Indra K.
Nooyi.
Indra K. Nooyi has held the CEO position since 2006 and the role of Chairman since 2007.
Moreover, Nooyi has had extensive experience with the company. Since 1994, Nooyi has worked in
various functions including: Strategic planning, corporate strategy and development, finance,
business process optimization, information technology and investor relations. She understands and
knows the business.
Zein Abdalla, president of PepsiCo, assumed this role in 2012, and has been with the company since
1995. Abdalla, overlooks all of PepsiCo’s global category groups, operations and marketing services
and category strategies. His focus is to work with geographic business segments to create innovation
and build brand while significantly reducing cost within the process.
Hugh F. Johnston, executive vice president and Chief Financial Officer, assumed this role since
2010, and has been with the firm since 1987. Johnston is responsible for strategic financial
leadership, ensuring the company’s capital structure, financial systems and financial models are in
line with company’s strategy.
Industry Overview: Industry Characteristics: PepsiCo, Inc. operates in the Food and Beverages
industries. The global food and beverage retail industry has continued significant growth over the last
five years and is expected to continue, reaching approximately value of $5,776 billion dollars in 2017
with a compound annual growth rate of 5% over the next five years.
The global beverage market is divided between alcoholic and non-alcoholic.
Beverages Industry Key Trends: Beverage – The market is flooded with innovative products which
lead to the global beverage industry’s highly competitive nature. Customer loyalty is vital to the
industry’s growth and to attain this, companies constantly need to develop innovative high quality
products that satisfy customers taste.
PepsiCo only offers non-alcoholic products. Their beverages products are diversified including:
bottled water, juice, regular coffees, dairy drinks, energy drinks, sports drinks, soft drinks and others.
Soft Drinks Industry is separated into mature developed markets where growth is flat and developing
markets where growth still exists. Bottled water continues to show great strength in growth with
projected growth rate of 5.4% in volume terms this upcoming year. Energy drinks have also shown
great prospects with average growth in the past 5 years being 10% per year.
Key Industry Players: The Coca Cola Company, with its main strength in its Coke product and most
recognized brand name in the world and Dr. Pepper Snapple Group, prides itself in diverse portfolio
of CSD and non CSD products including brand names such as 7-Up and Snapple.
5. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Exhibit:8
Industry Leaders North America Market
Share
Beverages
Snacks
PEP Key Mergers & Acquisitions
2006 - IZZE Beverage Company ACQ
2007 - Naked Juice Company ACQ
2009 - Calbee Foods Strategic Alliance
2010 - Wimm-Bill-Dann ACQ
2011 - Tingyi Holding Strategic Alliance
2012 - Diamond Star Agreement
2013 - The Müller Group JV
ACQ = Acquisition
JV = Joint Venture
Innovative Products: Within the food and beverage industry, it is very important to constantly
produce new and trendy products that consumers like. Companies that are able to produce new and
innovative products that consumers like are able to build brand loyalty and are more likely to be
industry leaders. In 2013, PepsiCo was able to release four new products, Mountain Dew Kick Start,
Gatorade Frost Glacier Cherry, Starbucks Iced Coffee, and Lipton Pureleaf; each individually
achieved $100 million in sales. Currently, PepsiCo has been in efforts of releasing three types of
Pepsi-Cola products made with real sugar. The three offerings: “Pepsi Made with Real Sugar”, in its
original, vanilla and cherry flavors.
The Coca Cola company also released Diet Coke Frost, a new product as low calorie frozen
carbonated beverage, and also Coca Cola Life, coke that made with a blend of sugar and stevia, as
opposed to artificial sweeteners. Recently, the Coca Cola company released a new Sprite 6 Mix, a
limited flavor of cherry and orange taste. Companies need to constantly create innovative products to
appeal to the ever changing consumer taste.
Aggressive Advertisement/ Efficient Pricing: Marketing is an essential investment in growing and
sustaining the consumer market especially when introducing new products into the market. All major
industry players are at the forefront with marketing and advertising. PepsiCo with its heavy
investments in 2014 Super Bowl celebrations ads, and holding Ad campaign contests including
“Create to Celebrate” a Black history month art contest. Whereas, Coke has recently partnered as the
main drink provider with 2014 Winter Olympics and the upcoming 2014 FIFA World Cup this
summer. Companies in the beverage industry also are very diligent in their competitive pricing
strategy against their competitors, where all their products act on very small margin, therefore it is
essential for them to get the least cost of goods possible and selling it at the highest price they can in
comparison with their competitor.
Supply Chain Management: In the food and beverages industry, it is essential to have an effective
and efficient supply chain between company and third-party companies such as beverage bottlers.
Industry leaders are able to create supply chain networks that can help company generate great
productivity savings. PepsiCo is expected to generate $5 billion dollars in savings from 2015 to 2019.
While, Coke’s “2020 vision” plan is expected to save $1 billion through its supply chain in the next
two years. In more detail, for example, PepsiCo is plans to invest in 1 self-manufacture plant versus
the usage of eight to ten distribution centers lessens vehicle, fuel, transportation, and other overhead
costs that it takes in the process. Companies who have an integrated supply chain network definitely
have an upper hand within the industry.
Barriers to Entry: In the food and beverage industry, it is hard for new companies to create a well-
established brand name for themselves. For a company to be successful in this industry one must
have quality and innovative products that have consumers recognize. It is all about the brand loyalty.
For industry leaders like the Coca Cola Company, PepsiCo, and Dr.Pepper, they are all big well
established companies that have been in the industry for a long time and basically control this
industry. These industry players analyze consumers’ habits in great detail, and have dedicated
departments looking for the next big consumer trend in developing their next innovative product. For
a newly established company in this industry, it is hard; it must compete against the big industry
leaders for consumer attention.
Mergers & Acquisitions: M&A is key trend within the food and beverage industry, as big industry
leaders are constantly looking for innovation, and most often coming from smaller companies to
acquire. Some of the key PepsiCo, Inc. recent M&A and JV include: Izze Beverage Company (2006),
Naked Juice (2007), Wimm- Bill-Dann (2010), Tingyi Holding (2011), Diamond Star (2012), The
Müller Group (2013). These partnerships and acquisitions have enhanced PepsiCo’s product
portfolio as well as gain advantages such as international growth and efficient distribution channels.
6. PROS:
Dividend Aristocrat
Productivity Savings
Strength in Snacks Business
Strength in Emerging Market
CONS:
Slowing sales in CSDs
QUESTIONABLE:
PepsiCo Split Up
Exhibit 9: Annual Cash Dividends
Exhibit 10: Productivity Savings
Investment Summary: PepsiCo, Inc. is currently trading at a fair valuation compared to historical
averages. We issue a HOLD recommendation for PepsiCo because we have a target price of $87.57
and the share price currently is hovering around $ 85. And for a number reasons listed below,
PepsiCo is a good company to hold in any diversified portfolio as of right now.
Strong Commitment to Shareholder Value/Dividend Aristocrat: Company is a cash dividend
company that values its shareholders, as it looks to increase its dividends and share repurchases in
2014. The company has announced a 15% increase from 2013 annual dividend of $2.27 per share to
$2.62 per share. This marks the 42nd
consecutive annual increase in dividends per share. Moreover, it
will also increase its share repurchases program from 2013 of 3 Billion to 2014 of approximately 5
billion.
Commitment to Productivity Savings/Cost Cutting: Company is unleashing and extending their
$ 1 billion annual productivity savings target through 2019. PepsiCo seeks to improve productivity
by focusing on automation, shared services, restructuring manufacturing, and restricting global
transportation management system. (i.e., capital reduction, less usage of trucks and fleets, fuel &
inventory reduction.)
Strong Sales in Snacks Business: PepsiCo’s Frito Lay division continues to lead the company with
great growth. In the recent fourth quarter of 2013, PepsiCo’s snacks division volume grew 3% and
brought in $7.9 billion in revenue. And in third quarter of 2013, snacks division posted 7% organic
revenue growth including 5% revenue growth in the Frito – Lay division. The snacks business as
noted earlier generates 66% growth of PepsiCo overall. We believe that this will continue to be the
forefront driver in leading PepsiCo, as Frito Lay is one of the most well-known and recognizable
snack brands.
Strength in Emerging Markets/Diversification of Products: PepsiCo continues its strong
performance in emerging markets. The heavy investments in India, Asia, and Russia, are showing
promising results in these key markets. There is still a lot of room for PepsiCo to grow in these
countries, and being able to leverage themselves with their promising snacks brands in these
countries such as India and China will be key. Moreover, we believe that PepsiCo’s diversification in
their products selections with both snacks and beverages (i.e., juice & water brands) will help them
succeed in the emerging markets.
Slowing Sales in Carbonated Soft Drinks Industry: Key risk when looking at the PepsiCo, as the
consumption of CSDs continues to decline. Since 1998, the per capita consumption of CSD dropped
from 54 gallons to today’s figure of 44 gallons a year, and the consumption of CSDs is forecasted to
drop significantly in the next five years. With the continuation of increasing awareness of consumers
about negative health impact of CSDs and also regulations put forth on unhealthy snacks and soda,
we would expect to see the numbers and sales in CSD for PepsiCo to continue to decline in growth.
However, we should pay close attention to the new products that PepsiCo has stated that it will
release as natural sweeteners products, if consumers will react positively to these new products, we
may see flat to low single digit growth for PepsiCo in the CSD market again.
Active Investor wants Split Up: Throughout 2013 until now, Nelson Peltz, owner of $1.2B common
shares of PepsiCo has been on the forefront of pushing for separation of snacks and beverages into
two independent entities which he argues would create more shareholder value. On the other hand,
board of directors and mgmt. have argued the company to stay as “one”. We believe, if there was a
split-up, it would not happen anytime soon, at least not within the next one or two years. Nextly, we
believe that a split up will not be a good long term goal. A unified company with snacks and
beverages complement one another for the average consumer.
7. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
CAPM Legend
= risk free rate (yield curve)
= beta of PepsiCo
( ) = risk premium
= epsilon of PepsiCo
PepsiCo, Inc. Target Prices
PCTL DCF RI
20% $68.87 $70.64
25% $71.09 $73.05
30% $73.20 $75.34
35% $75.47 $77.46
40% $77.77 $79.67
45% $79.90 $81.94
50% $82.10 $84.25
55% $84.75 $87.04
60% $87.57 $89.93
65% $90.32 $93.10
70% $93.60 $96.76
75% $97.78 $101.0
80% $103.0 $106.0
( )
Valuation:
Two detailed valuation models were constructed to value PepsiCo, Inc. and they are: Discounted
Cash Flow & Residual Income. Residual income model values the firm from today’s common equity
plus the Present Value of future Residual Income. Discount Cash Flow Model values the firm from
today’s common equity plus the Present Value of future Free Cash Flow.
Pro-Forma Financial Statement: Based on PepsiCo, Inc. for being an industry leader in the
consumers staples industry since 1965, the model assumes constant growth within range, which
means that we have omitted all outlier years or years with extreme high or low growth.
Sales Growth Forecast: The sales growth is the most important, and first line of financial statement
variables. We looked at the historical 20 years (1993 – 2012) sales revenue growth, and believe it
was adequate to use Min 0.3%, Avg 6.2%, and Max 9.6%.
Other Forecast Estimates: Forecasts of other financial statement items are based on their historical
value and relative relationship to sales growth. (i.e., cost of goods sold as percentage of sales
revenue). Moreover, for each financial statement item, Min, Avg, and Max are provided with
forecasted estimates.
Terminal Growth Forecast: The terminal sales growth is assuming top line sales to grow into
infinity; therefore, using a rather conservative estimate is a good decision. A small change in estimate
will have a big effect on our valuation. In the historical 20 years, company grew at 2% from 25
Billion to 65Billion in sales revenue. Given our current market conditions and saturated market in
both U.S. and emerging market with more competitors, we believe a range of 1 to 1.25% terminal
growth is reasonable.
Cost of Capital/ Discount Rate: Both models require an appropriate estimate of cost of equity to
effectively value PepsiCo, Inc. The capital asset pricing model (CAPM) as shown in the following
equation is main model to calculate discount rate for our model. Beta, risk premium, and epsilon are
all simulated values using triangular distribution based on CAPM input assumption estimates. The
only variable not simulated is our risk free rate. All cost of equity calculations and assumptions are
shown in (appendix IV).
Target Price: We arrived at our average target price of $82.10 and $84.75, with discounted cash
flow and residual income model respectively. We also believe that PepsiCo, Inc. price will likely fall
between 35 – 65 percentiles which is range of $75.47 - $ 90.32 for the 52 week range going forward.
The free cash flow to common equity and residual income calculations are shown in appendix 5 and
6).
(Valuation- Appendix 2-6)
8. Exhibit 11: PepsiCo, Inc. Gross Profit &
Sales Revenue(Net) Comparison
(1993- 2013)
Exhibit 12: PepsiCo, Inc. Sales & Cost of
Goods Financials (2008 – 2013)
Exhibit 13: Current Ratio & Quick Ratio
Comparison (1993 -2013)
Exhibit 14: Operating Cash & Market
Securities(1993- 2013)
Financial Analysis:
Increasing Profit PepsiCo, Inc. has proven its ability to increase its profit. PepsiCo is a profitable
company. And it is forecasted to continue its profitable trend going onward. Key findings including:
PepsiCo’s top line sales have increased from 43 billion in 2008 to 66 billion now which is a 53%
increase. Similarly, it has also grown its gross profit dramatically within the five years from 24
billion to 37 billion now which is a 55% increase. PepsiCo has proven to grow their sales through
careful management and knowing what consumers want. The company also focuses itself on
effective cost-cutting.
Key Financial Ratios: PepsiCo, Inc. key profitability ratios show that is a company profitable among
its peers in the industry. Return on equity 28.7%, net profit margin 10.14%, return on assets 8.86%,
return on investment (TTM) 14.70%.
Liquidity: A company’s financial ability to pay off short term and long term debt is a key
consideration in looking when valuing a company. PepsiCo, Inc. in terms of its liquidity and ability
to pay off debt is in its moderately fair range. Mainly, company is able to meet its short-term
obligations with good current ratio and quick ratios; however the downfall is that the company holds
too much long term debt.
Short Term Obligations: Since 2011, PepsiCo has improved its current ratio and quick ratios
substantially to current levels of 1.24 and 0.93 respectively. Both ratios look at the components of
current assets against the current liabilities. This shows that PepsiCo is improving its liquidity
position which is good, financially prepared in terms of market downturns.
Long Term Debt to Capital Structure: PepsiCo, Inc. has held a more leveraged position since 2006,
borrowing more long term debt for financing, and has increased their debt to equity ratio dramatically
from 0.16 to 1.40., which is now slightly above the industry average, but still fairly in sync within the
consumer staples sector.
Good Cash Flow: Holding a good amount of cash and having efficient cash flow is good for any
operating business. PepsiCo, Inc. is strong in holding vast amount of Operating Cash and Market
Securities, and has grown this asset account on the balance sheet to its current new high of 9.68
billion. Moreover, as mentioned earlier, the firm has a positive annual net change in cash.
Intangibles/Value: PepsiCo, Inc. is a big global food and beverage company with many different
patents and valuable reputational brands. Therefore, the intangible account is a big part of the firm’s
balance sheet. Since the year of 2010, there has been a huge jump in intangibles growth making its
current intangibles value to be at its company’s highest level. The intangibles value on the balance
sheet justifies that the company has a very well-known brand and is a company that creates value for
shareholders. Moreover, key acquisitions and partnerships including Wimm- Bill-Dann and Tingyi
Holding Company, in 2009 and 2010 is justifiable in creating the huge spike in intangible value.
Turnover Ratios: In order to understand how effective a company is in generating sales compared to
its input variables, different ratios such as net operating asset, working capital, PP&E turnover ratios
are used. PepsiCo, Inc. in recent trends have underperformed in all three of these ratios showing
slightly below company historic average levels, showing that company can improve on its efficiency
in terms of generating sales from its assets, working capital(current money available for immediate
usage), and long term plant property and equipment investments. The company management has
certainly made note of these low and decreasing ratio levels, as they have pin-pointed cost cutting
and making productivity more efficient to be a key business strategy going forward.
(Financial Analysis – Appendix 7)
9. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Key Investment Risks: All companies face various risks. In order to truly value PepsiCo accurately,
it is essential in understanding the various risks that the company faces. The following are key risk
factors that affect PepsiCo, Inc.
Macroeconomics Risks – Moderate - PepsiCo is a global company that operates in many different
countries, unfavorable economic conditions including: adverse changes in interest rates, volatile
foreign exchange markets, and commodity markets will have major financial effects on the company.
Interest Rates: PepsiCo uses various interest rate derivative instruments to hedge and manage their
interest expense and foreign exchange risk. Therefore, an increase in interest rate will have adverse
results in increasing company’s net interest expense. In 2014, interest rates are expected to rise, as the
economy grows and unemployment rates decrease. We believe that there is more upside in the
interest rates rising, which will cause borrowing to be more costly.
Foreign Exchange: PepsiCo operates on a global scale, as 49% of the company’s net revenue is
earned outside of the U.S. (Russia, Mexico, UK & Brazil accounts for 25%). This makes the
company susceptible to currency exchange risk. In early 2013, the devaluation of the Venezuelan
Bolivar had major negative effects on the 2013 first quarter financials. The devaluation of the
Venezuelan Bolivar from 4.3 VEF/USD to 6.3 VEF/USD had depreciation effects of $111 million
dollars. However, we believe that PepsiCo is prepared, as other currencies that the company operates
in will offset the depreciation effects, moreover company also uses foreign currency derivatives to
hedge against currency risk.
Commodity Prices: PepsiCo utilizes vast amount of raw materials and goods including: sugar cane,
corn, wheat, rice, oats, potatoes, and various fruits to produce their products, making them
susceptible to changes in commodity prices. We expect commodity prices to inflate in 2014 due to
the economy growing again; prices of commodity are going to rise. PepsiCo is prepared for the
commodity price inflation. The company uses hedging strategies such as derivatives with short term
contracts of less than 3 years to economically hedge price fluctuations related to metals, energy, and
agricultural products. We also expect the company to increase prices of products to offset this
commodity price inflation.
Market Risks – Moderate
Changing Consumer Taste/Health Awareness: One of the increasing trends within the soft drinks
industry is the changing preference of consumers. As obesity and health issue continues to be a
concern globally given USA and Mexico are the two top countries with obesity problems, they are
also two key markets to PepsiCo. Recent quarter sales have shown the decline in CSD volume
continues, and it is affecting all the major companies in the industry including Dr. Pepper & Coca
Cola. PepsiCo has been on the forefront of this problem, by diversifying its portfolio of products and
innovation of new products with stevia and aspartame replacing sugar.
Regulations/ Mexico Taxes: Regulations will continue to play a key risk in the snacks and soft
drinks industry. Regulations in the recent years have increased in its efforts in trying to limit
consumption of sweetened drinks and snacks. In October 2013, Mexico regulators passed a tax
excising 1 MXN per liter on sugary drinks and 5% tax on snack foods. We believe that it will have
negative effects on Latin America sales volume, but the growth potential in this region is so high, it
will offset the cons of the taxes. Going onward, we will see more progression in regulations;
however, we believe that the company has diversified itself well enough, outside of sugary drinks and
unhealthy snacks that it has hedged against this risk fairly well.
10. Current Analyst Research Notes and other Company News:
May 6, 2014: PepsiCo Inc. declares a 15 percent increase in annual dividend, from an annual rate of
$2.27 to $2.62 per share on common stock. Payable on June 30 to shareholders of record as of June 6.
May 5, 2014: PepsiCo, Inc. and The Coca Cola Company have announced to remove controversial
ingredient called brominated vegetable oil from their drinks. As ongoing petitions and advocacy has
pressured both companies to do so. The BVO ingredient is currently used in Mountain Dew, Amp
energy, and Gatorade products.
April 8, 2014: PepsiCo, Inc. plans to release three types of Pepsi-Cola sweetened with real sugar and
not with high fructose corn syrup. They will be marketed as “Pepsi Made with Real Sugar”, coming
in three flavors: original, vanilla, and wild cherry.
April 7, 2014: Cheetos and Doritos, two of PepsiCo’s Frito- Lay division are releasing a new snack
mix called “Cheetos Flamin’ Hot/Doritos Dinamita Chile Limon Mix” which is a one of a kind snack
mix combining Cheeto’s Flamin Hot snacks with Doritos Dinamita Chile Limon snacks.
April 4, 2014: PepsiCo, Inc. reported 2014 first quarter earnings with $12.6 billion in first quarter,
ahead of analysts’ estimates of $12.4 billion. Net income was up 13% to $1.22 billion and earnings
per share came in at 79 cents; 10 cents per share higher than a year earlier. Still maintaining its
forecast for the year and expects organic revenue to rise by mid-single digit percentage this year.
April 2, 2014: PepsiCo, Inc. and Major League Baseball Properties agree on a multi-year extension of
their sponsorship agreement, building on the over 15 year partnership.
February 27, 2014: Shanghai Disney Resort announced a multi-year strategic alliance with PepsiCo,
Inc. and Tingyi Holding Corp., which recognizes PepsiCo and Tingyi Holding as the primary
beverage suppliers to the resort.
February 13, 2014: PepsiCo, Inc. reported 2013 fourth quarter earnings with $20.12 billion and $66.4
billion for the 2013 full year. The company also posted $1.05 per share, $0.04 ahead of analysts’
expectations. Strong performance from Frito Lay North America of 4% organic revenue growth, and
developing and emerging markets also showed strength with 10% organic revenue growth.
Disclosure Notice:
I, Hubert Lo, hereby certify that the analysis provided in this assignment reflects my
personal opinion about PepsiCo, Inc. Neither my compensation, nor my academic
performance will be directly or indirectly enhanced by the opinions outlined above.
11. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
APPENDIX SECTIONS
-Valuation-
Appendix 2: Sales Growth Forecast Assumption: The sales growth is the most important, and first line of the
financial statement variables, because it has a trickle-down effect on every financial statement item. Therefore, it is
essential and look at this item in detail. I created graph of sales growth for the past twenty years (1993 – 2012), the outlier
years of high sales growth and low sales growth were omitted, (1994, 1997, 1999, 2002, 2010, 2011, 2012). The min,
average, and max were used for sales growth forecast estimates after omitting outliers. Min 0.3%, average 6.2%, maximum
9.6%.
Appendix 3:
The following is the Pro-forma Assumptions used in DCF and Residual Income Valuation:
Minimum Average Maximum
Income Statement
Assumptions
Sales Growth 0.3% 6.2% 9.6%
Cost of Goods/ Sales 40.0% 41.2% 42.2%
R&D/ Sales 0.5% 0.8% 1.0%
SG&A/ Sales 35.2% 37.2% 39.4%
Dep & Amort/ Avge
PP&E and Intang.
7.5% 8.2% 8.8%
Net Interest Expense/
Avge Net Debt
5.0% 6.8% 7.9%
Non-Operating
Income/Sales
0.1% 0.6% 1.3%
Effective Tax Rate 23.0% 26.0% 30.5%
Minority Interest/After
Tax Income
0.3% 0.5% 0.6%
Other Income/Sales 0.0% 0.0% 3.1%
Ext. Items & Disc. Ops.
Sales
0.0% 0.0% 0.0%
Pref. Dividends/ Avge.
Pref. Stock
0.0% 0.0% 0.0%
-40.0%
-30.0%
-20.0%
-10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
1 3 5 7 9 11 13 15 17 19
Sales Growth(1993 - 2012)
Sales Growth
12. Minimum Average Maximum
Balance Sheet
Assumptions
Working Capital
Assumptions
Ending Operating
Cash/Sales
5.2% 7.4% 9.6%
Ending
Receivables/Sales
10.1% 10.4% 11.1%
Ending Inventories/Sales 10.0% 12.5% 13.7%
Ending Other Current
Assets/Sales
1.9% 2.4% 2.8%
Ending Account
Payable/Cost of Goods
Sold
13.0% 16.0% 20.4%
Ending Taxes
Payable/Sales
0.5% 1.1% 2.0%
Ending Other Current
Liabilities/Sales
9.7% 11.4% 13.0%
Other Operating Asset
Assumptions
Ending Net PP&E/ Sales 26.7% 27.8% 29.6%
Ending
Investments/Sales
9.2% 10.0% 10.9%
Ending Intangibles/Sales 20.8% 22.2% 24.5%
Ending Other Assets/
Sales
1.5% 3.3% 4.1%
Other Operating Liability
Assumptions
Other liabilities/Sales 10.4% 12.0% 14.0%
Deferred Taxes/Sales 4.2% 5.6% 6.7%
Financing Assumptions
Current Debt/Total
Assets
1.5% 1.8% 2.0%
Long Term Debt/Total
Assets
15.8% 18.6% 23.6%
Minority Interest/Total
Assets
0.0% 0.0% 0.1%
Preferred Stock/ Total
Assets
0.0% 0.0% 0.1%
Dividend Payout Ratio 34.0% 36.5% 40.0%
13. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Appendix 4: Cost of Capital Estimation
CAPM Model: ( )
Beta ( : The Beta of PepsiCo, Inc. was calculated by finding the stock price of S&P 500 and stock price of PepsiCo,
Inc. for the last 20 years into monthly data from (January 1993 to December 2012). Secondly, we then utilize the natural
logarithm of the prices to find our returns in monthly data. Thirdly, we use linear regression with X variable as S&P 500
monthly returns and Y variable as PepsiCo, Inc. monthly returns and analysis shows us a beta being 0.67 and standard error
of 0.07. The following output is regression analysis of S&P 500 and PepsiCo, Inc. monthly returns:
Below are the Beta assumptions inputs into the CAPM model in calculating the discount rate:
Beta Assumptions Minimal Average High
0.59 0.67 0.74
Standard Error 0.0741
We simulated the three betas, (min, average, and max), with the triangular distribution, as an input into our capital asset
pricing model.
Epsilon( : The epsilon term is the residual values component within the regression output, and is component of the
Capital Asset Pricing Model that measures the firm’s specific idiosyncratic risk which is also same as the error term in the
regression model. We ran a regression model of S&P 500 returns and PepsiCo returns as in the output shown above and
calculated the residual values, and for monthly data and sum up the residuals into annual residuals, and omitted outliers and
similarly calculated the average epsilon and standard error of epsilon to compute low and high epsilon. Based on this
regression model, the epsilon term has little to medium effect on the capital asset pricing model, because the standard error
deviation is high. Similarly, we inserted these assumptions following a triangular distribution into our model.
Below are the Epsilon assumptions inputs into the CAPM model in calculating the discount rate:
Epsilon Assumptions Minimal Average High
-3.14% -0.003682% 2.41%
Standard Error 2.773%
14. APPENDIX 4 CONT:
Risk Free Rate of Return ( : The risk free rate is theoretical rate of return of an investment with zero risk. We based the
risk free rate return using the yield curve from today’s rate (year 1 to year 12) and using 30 year yield rate for our terminal
value. We utilized the current yield rates and inputted into our capital asset pricing model. The following is a yield curve
as of 3/7/2014.
Below are the risk free rate of return assumptions inputs into the CAPM model in calculating the discount rate:
Risk
Free
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2043
0.13% 0.38% 0.79% 1.22% 1.65% 1.96% 2.27% 2.48% 2.64% 2.80% 3.72%
Risk Premium( : The risk premium is the expected return in excess of the risk free rate of return, I gathered the
historical 20 year monthly data from January 1993 to December 2013 of S&P 500 Price Close, and Libor Rates close. Then
calculated the returns for both S&P 500 and Libor Rates using natural logarithm and compounding methods respectively,
and calculated the difference to obtain the risk premium monthly rates. Next, we sum up the monthly risk premium rates
into annual basis, and created a graph of the risk premium over the last 20 years. Then we omitted the outlier years and
found the minimum, average, and maximum risk premium values with the plus or minus standard deviation as our input
assumptions for the triangular distribution that we inserted into our capital asset pricing model. We thought this was
adequate risk premium range, because our model is a conservative long run model that is stable, on average risk premium
of the past has deviated roughly between 5-7%, and setting our maximum and minimum with the plus or minus calculated
3.55% is reasonable.
Below are the risk premium assumptions inputs into the CAPM model in calculating the discount rate:
Risk Premium Minimum Average Maximum Standard
Deviation
2.45% 6.00% 9.55% 3.55%
Exhibit: Yield Curve as of 3/7/2014
15. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
APPENDIX 4 CONT.
Cost of Equity Assumptions:
Below are the all assumptions used inputs into the CAPM model in calculating the discount rate:
Other Assumptions Minimal Average High
Beta 0.59 0.67 0.74
Risk Premium 2.45% 6.00% 9.55%
Epsilon -3.14% -0.003682% 2.41%
Risk Free Rate Range
0.13% 3.72%
Each of the inputs, BETA, Risk Premium, Risk Free Rate are all simulated with triangular distribution to utilize random
error and ultimately the average cost of capital (output) is calculated as randomly generated number between the range of
3.82% and 6.47%. (2013 – 2022)
Average Cost of Common Equity using Monte Carlo Simulation (10,000 Simulations):
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Average
Cost of
Common
Equity
3.82% 4.06% 4.45% 4.49% 5.31% 5.63% 5.94% 6.14% 6.32% 6.47%
16. APPENDIX 5: Discounted Cash Flow (DCF) Valuation
To effectively value the current price of Pepsi, Co Inc., we utilized both the discounted cash flow model (DCF) and Monte
Carlo Simulation in E-Val. Discount Cash Flow (DCF) model values the firm from today’s common equity plus the present
value of future free cash flow. Monte Carlo Simulation was also used to incorporate simulation for random errors, allowing
for all items of our pro-forma financials to be all random, in consistence with our historical 20 year values. (1993 to 2012).
Free Cash Flow to Common Equity
Based on simulated cost of equity and terminal sales growth, the eVal model analyzes the forecasted cash flow. The
following is a table showing simulation average estimated cash flow of estimated free cash flow to equity for next 10 years
(2013 to 2022).
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
$6.88 m $7.39m $7.77m $8.23m $8.62m $9.16m $9.60m $10.1m $10.63m $11.26m
Average Present Value of Free Cash Flow:
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
$6.63 m $6.81 m $6.85m $6.81m $6.65m $6.59m $6.44m $6.33m $6.18m $6.10m
The free cash flows are then discounted and used in calculating PepsiCo, Inc’s price per share. Taking into account of a
simulated cost of capital, and simulated terminal growth rate, we discount the present value beyond 10 years and also the
present value of the first 10 years, ultimately coming up with a value attributable to common equity in today’s time. This
value is then divided by 1.54 million shares outstanding to come up with a forecast price per share. We then run 10,000
trials using the Monte Carlo simulation on the forecast price per share, and the 50th
percentile price or fair price value that
we come up with is $82.24.The following are exhibits on the 20th percentile to 80th percentile forecasted target prices and
also the normal distribution showing the same data.
17. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
APPENDIX 5 CONT:
Valuation (Discounted Cash Flow) Method:
We came up with our target price by firstly forecasting the top sales line data and other financial statement accounts. Then
analyzed the last 20 years data (1993 – 2012) and omitted the outliers, and pin pointed the minimum, average, and
maximum assumptions as mentioned previously.
After defining the assumptions in the income statement, balance sheet -working capital, operating capital, operating asset,
operating liability and financing. We utilized the triangular distribution function to create randomize values following a
triangular shape function within our value assumptions. Next, we ran 10,000 Monte Carlo simulations for the price per
share calculated by discounted cash flow.
Overall, we believe with our discounted cash flow valuation model that current price of PepsiCo, Inc., $82.15 is trading
near its fair value price of $82.10. We have set a price target of $87.57 looking at the value price 60th percentile. We also
believe that the range that PepsiCo, Inc. price will likely fall between 35 and 65 percentile which is range of $75.47 to
$90.32 for the 52 week range going onward.
Percentiles DCF
Target
Price
20% $68.87
25% $71.09
30% $73.20
35% $75.47
40% $77.77
45% $79.90
50% $82.10
55% $84.75
60% $87.57
65% $90.32
70% $93.60
75% $97.78
80% $103.04
18. APPENDIX 6: Residual Income Valuation
The residual income valuation model is used to find the earnings for a period in excess of investor’s required return on the
beginning of period investment (common equity). We use the residual income model to see the amount of income generated
by the company taking already into account for the cost of equity capital. Based on simulated cost of equity and terminal
growth rate, the following simulated average residual income:
Residual Income
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
6.40m 7.69m 8.01m 8.32m 8.66m 9.03m 9.43m 9.86m 10.36m 10.86m
The residual income values are then discounted to present time, firstly discounting the present value of the first 10 years
(2013 – 2022) and the present value of beyond 10 years. Then, the present value of first 10 years discounted, present value
of beyond 10 years discounted, and common equity as of December 31, 2012, the three are added to sum up the value
attributable to common equity and divided by 1.54 million common shares outstanding to come up with the forecast price
per share using the residual income valuation model. Then we simulated using the Monte Carlo simulation for the
forecasted price per share by 10,000 trials, and the 50th
percentile price we came up with is $84.25 per share. The following
is the normal distribution and percentiles of Residual income target price for PepsiCo Inc.
Percentiles RI Target
Price
20% $70.64
25% $73.05
30% $75.34
35% $77.46
40% $79.67
45% $81.94
50% $84.25
55% $87.04
60% $89.93
65% $93.10
70% $96.76
75% $101.03
80% $106.04
19. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
APPENDIX 7: Financial Statement Analysis
Profitability
Liquidity Ratios
21. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Exhibits Appendix
Exhibit 3: Three Different Brand Images: Fun- for- you, good- for- you, better-for-you.
Exhibit 1: Sales Revenue in Products and Geographies
Exhibit 2: Sales Revenue & Growth % Breakdown
22. Exhibit 4: PepsiCo Products Globally
Exhibit 5: Net Change in Cash Graph
Exhibit 6: Dividend Payout Ratio Graph
Exhibit 7: Common Shares Outstanding
23. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Exhibit 8: Industry Leaders North America Market Share
Data Source: 2013 Company Annual Report
24%
21%
9%
8%4%
4%
5%
25%
U.S. Liquid Refreshment Beverage Category
Share % Retail Sales in Measured Channels
PepsiCo, Inc.
Coca Cola
Dr. Pepper Snapple Group, Inc.
Private Label.
Monster
Red Bull
Nestle
Other
37%
10%
4%
7%
3%
3%
6%
30%
U.S. Savory Snacks % Retail Sales in
Measured Channel
PepsiCo
Private Label
Kraft
Kellogg’s
Conagra
Synder’s Lance
Mondelez
Other
PepsiCo, Inc. 24.3%
Coca Cola 21.1%
Dr. Pepper
Snapple
Group, Inc.
8.9%
Private Label. 8%
Monster 4%
Red Bull 4.2%
Nestle 5.2%
Other 24.4%
PepsiCo 36.6%
Private Label 10.0%
Kraft 3.6%
Kellogg’s 6.9%
Conagra 3.3%
Synder’s Lance 3.5%
Mondelez 5.6%
Other 30.4%
24. Mergers & Acquisitions Timeline
2006 - IZZE Beverage Company ACQ
PepsiCo acquires Izze Beverage Company, an all-natural sparkling juices company.
2007 - Naked Juice Company ACQ
PepsiCo acquires Naked Juice Co., a line of healthful, preservative free juice drinks company.
2009 - Calbee Foods Strategic Alliance
PepsiCo and Calbee Foods Company announce a strategic alliance to make and sell a wide range of
food products in Japan.
2010 - Wimm-Bill-Dann ACQ
PepsiCo acquires Wimm-Bill-Dann, Russia’s leading branded food and Beverage Company.
2011 - Tingyi Holding Strategic Alliance
PepsiCo and Tingyi Holding, one of the major food and beverages companies in China, announce an
agreement to form a strategic alliance in China.
2012 - Diamond Star Agreement
PepsiCo announces an agreement with Diamond Star, one of the largest consumer packaged goods
distributors in Myanmar, to import, sell and distribute Pepsi-Cola, 7-Up and Mirinda.
2013 - The Müller Group JV
Müller Quaker Dairy, a joint venture between PepsiCo and The Müller Group open a new yogurt
manufacturing facility in New York.
25. Cal Poly SMPP ANALYST REPORT ANALYST: HUBERT LO
Exhibit 9: Annual Cash Dividends
Exhibit 10: Productivity Savings
Source: company annual report
Exhibit 11: PepsiCo, Inc. Gross Profit & Sales Revenue (Net) Comparison (1993- 2013)
26. Exhibit 12: PepsiCo, Inc. Sales & Cost of Goods Financials (2008 – 2013)
Exhibit 13: Current Ratio & Quick Ratio Comparison (1993 -2013)
$43.25 $43.23
$57.84
$66.50 $65.49 $66.42
$18.84 $18.60
$24.06
$29.07 $28.80 $28.77
Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
Last 5 years Sales Revenue & COGS
Comparison - billions
Sales Revenue Cost of Goods Sold
