PepsiCo, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

PepsiCo is a global giant in the food and beverage industry, known for a diverse portfolio of brands ranging from iconic soft drinks and salty snacks to healthy foods, all while it relies on an extensive distribution network.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

PepsiCo’s primary obligation is to ensure the distribution and sales of beverage and convenient food products to customers. These products range from their most known brands like Pepsi to other brands like Lays and Quaker.

PepsiCo operates through seven reportable segments, each serving a distinct market:

  1. Frito-Lay North America (FLNA), offering convenient foods in the U.S. and Canada.
  2. Quaker Foods North America (QFNA), providing cereals, rice, pasta, and other branded foods in the U.S. and Canada.
  3. PepsiCo Beverages North America (PBNA), specializing in beverages in the U.S. and Canada.
  4. Latin America (LatAm), offering beverages and convenient foods across Latin America.
  5. Europe, focusing on both beverages and convenient food businesses across Europe.
  6. Africa, Middle East and South Asia (AMESA), delivering its products in Africa, the Middle East and South Asia.
  7. Asia Pacific, Australia and New Zealand and China region (APAC), with a focus on Asia Pacific, Australia, New Zealand, and China.

Each of these segments serves distinct markets, and has its own supply and distribution chain.

PepsiCo generates revenue through multiple channels, including:

  • Independent Bottlers: Who then distribute beverages directly to retailers and consumers.
  • Direct-Store-Delivery (DSD) system: Using company-owned trucks to deliver to independent retail partners.
  • E-commerce: Through their own and third party e-commerce and retail partners.

The majority of its operating profits come from North America, so the company is heavily reliant on its success in these developed markets. They are also experiencing strong growth in certain emerging markets, like Latin America.

According to their latest reports, PepsiCo’s revenue for the 36 weeks ended September 9th, 2023, totaled $69.0 billion. Beverage sales generated more revenue (40.2%) than convenience foods (29.3%). A large portion of the revenue comes from Frito-Lay North America (31.5%), while Europe and Latin America also contributed significantly. The operating profit was 16.6% on average, but 14.5% in beverage and 17.3% in convenient foods.

Let’s analyze PepsiCo’s Moat, or lack thereof:

Moat Rating: 3/5

  • Brand Recognition: PepsiCo boasts a portfolio of well-known brands that generate a high degree of customer loyalty. Pepsi, Lay’s, and Quaker Oats are recognized around the world, creating a form of “sticky” demand that benefits the company. Consumers generally prefer brands they know and have had good experiences with, creating a hurdle for competitors to surpass and enter those spaces. These brands are built on decades of marketing, which also makes them hard to copy.
  • Distribution Network: PepsiCo maintains a massive distribution infrastructure that would be difficult for a competitor to replicate. The company’s delivery network allows its products to be readily available, a critical factor in maintaining sales volume. PepsiCo also has partnerships with distributors that allows it to quickly respond to market needs, this helps in keeping up with competitor and customer demands.
  • Economies of Scale: PepsiCo’s size allows it to achieve economies of scale, allowing the company to purchase supplies in bulk and minimize costs across operations, this advantage can be hard for smaller companies to replicate. They have been making investments to transform their operations with automation in production and distribution in hopes to increase efficiency and reduce expenses.
  • Switching Costs: The brand loyalty that PepsiCo has amassed does create a minor moat, which would lead to switching costs from loyal customers to try something new. Also, for smaller retailers, there is an advantage to sticking with PepsiCo, given that PepsiCo distributes a wide variety of beverages and convenience food products.

However, these moats are not unbreakable:

  • Competition: Despite the brand strength of PepsiCo’s brands, there is constant competition in the food and beverage industry. Competitors such as Coca-Cola in the beverage market, and Lay’s direct competition in the snack market, could potentially erode its dominance. Consumers can easily choose to buy a different soft drink or bag of chips if the price or quality is better.
  • Changing Consumer Preferences: The food and beverage industry is sensitive to changes in consumer tastes and preferences. The rising importance of “better for you” products puts pressure on the traditional soft drinks and salty snacks that PepsiCo sells. As the demand shifts to more healthy options, that has put pressure on PepsiCo to make innovative decisions, which have varying degrees of success. They are continuing to try their way into the healthier products trend by innovation and acquisitions.
  • Low Differentiation: A large amount of their product portfolio in convenient foods is similar, or interchangeable to other brand’s products, so consumers may not care about the specific brand, as much as pricing and availability, which leads to price-based competition.
  • Commodity Prices: Many of PepsiCo’s products are commodity-based which makes them susceptible to price fluctuations. In many cases, the price that is passed along is not enough to fully cover the costs of the company, thereby creating margin risk.
  • Regulation: With the government becoming more stringent on health related impacts from food and beverages, there may be new regulations around what can be sold and marketed. New laws and regulations are likely to increase costs for PepsiCo, and may limit their sales.

Risks to the Business Resilience:

  • Supply chain disruptions: Disruptions to global supply chains could affect PepsiCo’s ability to produce and deliver products, leading to increased costs and potential loss of sales.
  • Inflation: Higher ingredient prices, transportation and labor costs, can hurt profits and margins if PepsiCo is not able to pass them on to the consumer.
  • Foreign Exchange: PepsiCo operates in many countries, which makes the business very sensitive to fluctuations in foreign exchange rates, with a potential impact on reported profits and performance.
  • Geopolitical instability: As a large global company, geopolitical tensions and wars may cause supply chain disruptions, cause increased market volatility and make some markets unprofitable.

PepsiCo has been aggressively expanding their reach in developing and emerging markets to combat slower growth in their main markets. They have been doing this by investing in production and distribution plants and have been acquiring companies that are local and have brand recognition. This has paid off in Latin America and APAC markets where they have experienced higher revenue growth.

PepsiCo has implemented different strategic initiatives across different business segments. They have expanded into healthier products in the beverage segment and are pushing hard on convenience and better packaging options in the snacks business. They have invested heavily on e-commerce in all of their markets and are making acquisitions of new products in order to offer the best in class products for their customers.

Let’s dive into financials of PepsiCo:

Balance Sheet Health: 4 / 5

  • PepsiCo’s total assets are about $101 billion. Their short term assets like cash and cash equivalents and accounts receivable combined are approximately $29 Billion. Short-term debt and other obligations are about $36 billion, however they have been able to consistently pay off their debt obligations. They have goodwill and other intangible assets worth approximately $26 Billion that are difficult to evaluate. Their long term debt is around $38 billion dollars.
  • Cash flows have remained pretty consistent and positive in recent years. In 2022, they had $10.6 billion from operating activities while in the 36 weeks of 2023, the cash flow from operating activities was $7.6 billion. They are generating a large amount of cash, which could be used to lower their obligations in the long run.
  • PepsiCo continues to be a very well-capitalized company with a large amount of assets. They have a track record of handling their debt and obligations well. They also have a large amount of cash on hand that is able to give them the flexibility of capitalizing on new opportunities and also making large shareholder returns. However, goodwill and intangible assets make it difficult to truly understand the value of their assets.

Understandability Rating: 2/5

PepsiCo is a very complicated company that is involved in multiple markets and has lots of moving parts, which is why a lot of time needs to be taken to truly grasp its fundamentals. At a high level, most investors can understand that PepsiCo sells snacks and drinks, but that’s where their knowledge may end. It requires significant understanding to understand their diverse portfolio of brands across many different industries and the multiple distribution models that they use to deliver their products. They have also started expanding their operations into a more international base, which has added complexities that many may not know about. Finally, there are some accounting intricacies that make their value more opaque.

Recent Concerns and Management Commentary:

  • Product Recall: As seen in the latest 10-Q reports, one of their segments, QFNA, has been subjected to multiple recalls, which has negatively impacted their revenue and profits for this quarter. It was primarily a “Quaker Recall” for several brands. The company has taken additional expenses to ensure that a similar issue is not repeated and the products are safe.
  • Russian Operations: PepsiCo had some operational hurdles in Russia as a result of the war in Ukraine. They have suspended all sales and investments in Russia. They recognized asset and impairment charges in the past few quarters, but expect to continue in Russia under very limited operations.
  • Commodity Pricing Pressures: High input costs from commodities such as corn, oil, potatoes, and packaging can affect the financial results of the company. While they have been mitigating the impacts with price hikes and supply chain efficiencies, inflation remains a very present danger.
  • Share Repurchase Program: In the latest earnings call, they have reiterated their plan to buy back an extra 1 billion in shares. Given that the stock is trading at 25X earnings, it is hard to say whether it is the best use of capital, especially in a high interest rate environment.

In conclusion, the economic moat of PepsiCo is a wide, but ultimately fragile moat due to the constant change of consumer preferences and fierce competition. With a better understanding of their financial statements, it’s obvious that the company’s main goal is to keep improving its fundamentals while delivering shareholder returns. It’s also important to view PepsiCo through a lens of a very competitive food and beverage landscape that can create both risks and opportunities for long term investors.