The company's free cash flow is declining year by year, but its returns to shareholders remain generous. As one of the world's leading food and beverage companies, PepsiCo (PEP.O) is not just about Pepsi-Cola; it also operates snack foods and fast-food restaurants, with well-known brands such as Frito-Lay, Gatorade, Quaker, 7UP, and Tropicana, forming a complementary product portfolio. In 2019, PepsiCo acquired a stake in Wugu Mofang, becoming its second-largest shareholder. On February 23, 2020, Haoxiangni announced a definitive agreement with PepsiCo to sell 100% of Chinese snack brand Baicaowei for 5 billion yuan. Upon completion, PepsiCo's brand portfolio in China will be further enriched. Shareholders holding more than 5% of the company include The Vanguard Group and BlackRock, Inc., holding 8.22% and 7.63% respectively. -01- Business Overview PepsiCo operates in over 200 countries and regions, with business concentrated in North America, Russia, the UK, China, and Brazil. By country and region, the United States contributes the most to company revenue, with 2019 U.S. operating revenue of $38.644 billion, accounting for 57.5% of total revenue. 1. Price Increases Contribute More to Revenue Growth According to the restructured revenue segments for 2019: FLNA: Frito-Lay North America, including North American food and snack operations. Main products include dips, Cheetos cheese snacks, Doritos corn chips, Fritos corn chips, Lay's potato chips, Ruffles potato chips, and Tostitos corn chips, as well as Sabra dips produced in partnership with Strauss Group. QFNA: Quaker Foods North America, including North American cereal, rice, pasta, and other food operations. Main brands include Quaker Oats and its subsidiaries Aunt Jemima, Cap'n Crunch, Life, etc. PBNA: PepsiCo Beverages North America, referring to North American beverage operations, including beverage concentrates, syrups, and finished products. Brands include Aquafina purified water, Mountain Dew, Pepsi-Cola, Gatorade, Propel, Sierra Mist, and Tropicana. APAC: All beverage, food, and snack operations in Asia Pacific, Australia, New Zealand, and China. AMESA: All beverage, food, and snack operations in Africa, the Middle East, and Southeast Asia. LatAm: All beverage, food, and snack operations in Latin America. Europe: All beverage, food, and snack operations in Europe. In 2019, total operating revenue was $67.161 billion. The top four segments by revenue share were North American Beverages, North American Food and Snacks, Europe, and Latin America. North American Beverages is the largest revenue contributor, with 2019 PBNA revenue of $21.73 billion, accounting for 32.4% of total revenue. North American Food and Snacks ranks second, with 2019 FLNA revenue of $17.078 billion, accounting for 25.4% of total revenue. Europe and Latin America generated revenues of $11.728 billion and $7.573 billion in 2019, accounting for 17.5% and 11.3% of total revenue, respectively. In terms of revenue growth by segment, Europe had the highest growth rate, followed by North American Food and Snacks, with 2019 revenue growth of 7% and 4.5%, respectively. The North American Beverages segment, with the largest revenue share, grew at a relatively stable rate of 3% in 2019, up 2 percentage points year-over-year. Company revenue is typically determined by volume and net price. Since food and beverage volumes are inconsistent, Servings represents the company's combined volume. In 2019, combined volume grew 4% year-over-year, the highest growth rate in five years, though specific volume figures were not disclosed. Excluding structural changes such as acquisitions, divestitures, and currency effects, organic revenue represents the company's ongoing operations, with Volume representing the volume of products sold. Over the past five years, organic revenue has grown annually, with price having a greater impact on revenue growth than volume. In 2019, organic revenue grew 5%, with price contributing 4% and volume only 1%. In 2019, volume had a negative impact on revenue for North American Beverages and Europe, meaning these segments were driven by price increases; while FLNA, AMESA, and APAC were driven by both volume and price. 2. Acquisitions Enrich Product Portfolio Since revenue growth relies more on price increases than volume, sustainability is a big question mark, making external acquisitions a natural way to gain additional growth. In 2019, PBNA revenue grew 3%, with one-third contributed by acquisitions. In 2019, the company acquired CytoSport Inc., a U.S. manufacturer of sports nutrition or supplements. The fastest-growing region, Europe, benefited from the acquisition of SodaStream at the end of 2018. SodaStream is an international company that produces and sells soda makers and carbonated beverage concentrates and flavorings. In July 2019, the company reached an agreement to acquire Pioneer Foods, a South African food and beverage company, which will be integrated into the AMESA segment upon completion. In the Asia Pacific region, Tropicana formed a strategic alliance with Master Kong to launch co-branded juice products. Additionally, the company plans to acquire Chinese snack brand Baicaowei and maintain its independent operation. -02- Productivity Plan Due to sluggish growth, "cost reduction and efficiency enhancement" becomes more important. The company introduced "Productivity Plans" in 2012, 2014, and 2019. The 2014 Productivity Plan was completed in 2019, with pre-tax charges and cash expenditures close to the previously estimated $1.3 billion and $960 million, respectively. On February 15, 2019, the company proposed a new plan to simplify its business model by leveraging new technologies, enhancing automation, realigning marketing and information systems, and optimizing the supply chain, expected to be completed by 2023. The 2019 plan is expected to incur $2.5 billion in pre-tax charges and $1.6 billion in cash expenditures, with 70% of pre-tax charges for severance and other costs, 15% for asset impairment, and 15% for other charges. As of December 28, 2019, approximately $508 million in pre-tax charges and $1.6 billion in cash expenditures had been incurred. In 2020, the company expects to incur $450 million in pre-tax charges and $400 million in cash expenditures. These charges are primarily from the North American Beverages and Europe segments, accounting for 30% and 35%, respectively. The company stated that most of the Productivity Plan charges are severance costs. The author reviewed the company's employee count over the past five years and found no significant change. At the end of 2019, the company had 267,000 employees globally, including 116,000 in the U.S., an increase of 4,000 and 6,000 respectively compared to 2015. It seems the workforce will face a significant elimination round ahead. -03- Risk Factors Since company revenue is primarily driven by product prices, which are influenced by supply and demand, changes in consumer demand are a key risk point, ranking first in the risk factors section of the annual report. If a bottle of Coca-Cola and a bottle of Pepsi-Cola are the same price, which would you choose? Will "happy water for couch potatoes" continue to sell well? (Source: business insider) The global snack market is highly competitive, with low product differentiation, strong substitutability, and low customer brand loyalty. Consumer demand is constantly changing, and factors such as health, convenience, ingredient origin, and product quality can affect consumers, thereby impacting company sales. The second-ranked risk is that with global environmental concerns, changes in regulations regarding packaging materials like plastic are likely to increase production costs. -04- Financial Analysis 1. Growth Over the past three years, revenue has grown slightly. In 2019, revenue was $67.161 billion, up 3.9% year-over-year, with a CAGR of 1.59% from 2015 to 2019. In 2019, Coca-Cola's operating revenue was $37.266 billion, with a revenue growth rate of 17%, though revenue had been declining before that, with a CAGR of -4.2% from 2015 to 2019. PepsiCo's revenue growth is mediocre but relatively stable. 2. Profitability In 2019, PepsiCo's gross margin was 55.1%, remaining stable in recent years, slightly lower than Coca-Cola's 60.8%, a difference of 6 percentage points. In 2019, PepsiCo's operating profit was $10.291 billion, with an operating margin of 15.3%, down 0.3 percentage points year-over-year, 13 percentage points lower than Coca-Cola. Clearly, Coca-Cola's operating efficiency is significantly ahead. Although the Productivity Plan and revenue growth drove operating profit up, increased advertising and marketing expenses led to a slight decline in operating margin. In 2019, the company reduced costs by $1 billion through the Productivity Plan, but restructuring and impairment charges had a negative impact of $368 million on operating profit. Excluding this impact, the operating margin for the year was 15.9%, still far behind Coca-Cola's 28.3%. Now let's look at earnings quality. Over the past five years, PepsiCo's net cash ratio was below 1 only in 2018 at 0.75, improving to 1.31 in 2019, indicating a strong ability to convert profits into cash. 3. Balance Sheet Intangible assets are the largest component of total assets, with 2019 intangible assets of $30.111 billion, accounting for 38% of total assets. Goodwill accounts for about 20% of total assets, at $15.501 billion in 2019, resulting from acquisitions to expand market share. PepsiCo's debt-to-asset ratio is slightly higher than Coca-Cola's, with PepsiCo's ratio 5.5 percentage points higher at the end of 2019. Both companies' debt-to-asset ratios increased from 2015 to a relative high in 2017, with a slight decline in the last two years. 4. Operations The company's inventory turnover days and accounts receivable turnover days are around 40 days, while accounts payable days gradually increased to 91 days. The cash conversion cycle turned from positive to negative, at -12 days in 2019, indicating that the company may not even need to advance its own funds for inventory purchases and sales. 5. Cash Flow Operating cash flow is on a downward trend, while capital expenditures are increasing year by year, causing free cash flow to decline. In 2019, operating cash flow was $9.649 billion, capital expenditures were $4.232 billion, and free cash flow was $5.587 billion. In 2019, capital expenditures increased 28.9% year-over-year, with FLNA segment growing more, reaching $1.227 billion, up 46% year-over-year. According to the company's disclosed credit arrangements and long-term contract commitments, it needs to cover $2.849 billion in contractual liabilities in 2020, which current free cash flow is sufficient to cover. 6. Shareholder Returns The company returns value to shareholders through cash dividends and share repurchases. From 2015 to 2019, cumulative shareholder returns were $37.973 billion, while cumulative free cash flow was $34.430 billion, with the excess of $3.543 billion funded through financing. 7. Return on Invested Capital (ROIC) The company calculates ROIC as net income plus after-tax interest expense, divided by the sum of average quarterly debt obligations and average quarterly common shareholders' equity. NET ROIC excludes the impact of non-comparable items on top of ROIC. Based on the company's reported ROIC, the return on capital has been relatively stable over the past five years, at 22.3% in 2019, down 2.5 percentage points year-over-year. This is quite excellent. -05- Conclusion Unlike Coca-Cola, PepsiCo is not a company that relies solely on cola. The company's primary market is the U.S., with North American beverages and food contributing the most to revenue. In recent years, revenue growth has been driven mainly by price increases, and the company continues to expand its footprint through acquisitions to seek more growth. The company's gross margin is slightly lower than Coca-Cola's, but its operating margin is far inferior. The company's cash conversion cycle is negative, indicating strong bargaining power with upstream and downstream partners. The decline in operating cash flow and the increase in capital expenditures have led to a year-by-year decrease in free cash flow. However, the company remains generous to shareholders and performs well. Source: Market Value Storm (ID: mvlegend) Author: Erbing