The Faulty Thinking of Pepsi Bulls

 | Feb 16, 2012 | 7:30 AM EST
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Did anyone get the number of the truck that hit Pepsi (PEP)? I mean, what happened? If you compare Coca-Cola (KO) and Pepsi on a five-year chart, you'll notice that Coca-Cola is up 45% (plus dividends) while Pepsi only returned dividends (yawn).

Maybe the old school stock pickers out there can tell me. Wasn't Pepsi supposed to be the smaller of the two, with more growth opportunities ahead of it? Pepsi sold salty snacks, so it wasn't entirely dependent on case volume like KO. And wasn't that supposed to be a good thing? Pepsi had the cooler marketing. Coca-Cola had the polar bears that don't talk. Last week, Pepsi reported Q4 and fiscal 2011 year-end results. Is now the time to buy Pepsi or has the fizz gone flat?

Last Thursday, Pepsi said revenue for the quarter rose 11% to $20.2 billion. Higher commodity costs squeezed net income, which only managed to grow 4% to $1.4 billion. Worldwide beverage volume rose 3%. The salty snack business saw volumes rise 8% overall, but consumers in Asia, the Middle East and Africa really chowed down on the snacks. Volumes in those regions were up 15%.

North American volumes continued to struggle, declining 4%. Weak volumes in the carbonated soft drink business wrecked the positive growth seen in the non-carbonated beverage segment. Pepsi has been losing market share to KO the last few years and now Pepsi is planning a big advertising reboot. In 2012, Pepsi will spend an additional $500-600 million on advertising in North America in an attempt to regain share and case volume. (Worldwide, the company plans to spend another $600-700 million on sales and marketing.)

On the conference call, management didn't sound very confident about FY12. The company forecast a 5% decline in earnings per share, principally due to increased marketing and about $1.5 billion in higher commodity costs. Most analysts are looking for 3-5% revenue growth and weak operating margins because of continued investments in infrastructure. The company is part way through a $3 billion share repurchase program -- it spent $600 million buying back shares in FY11 -- and plans to gobble up a similar amount this year.

Flipping through a lot of the Street research, most analysts think PEP is a $70 stock. But why? Pepsi has been an inconsistent performer, especially in North America, its biggest market. Why reward a company that keeps losing market share in its biggest market? I know they have a lot of growth opportunities overseas, but if they can't execute in the USA what makes you think they can execute overseas? People point to Gatorade. Gatorade rapidly lost market share to other sports drinks and for the last three years was helpless to stop the losses. Finally, after reinventing Gatorade, repackaging it and rebranding it, Pepsi has been able to gain share back. So now they have to battle back with the rest of the lineup? Please. Coke has tremendous momentum. 

To me, Pepsi is a market performer.



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