A closer look at an activist's big turnaround plan for PepsiCo
Today, let's continue the conversation on beverage and snack giant PepsiCo (PEP)...
As a reminder, the stock piqued my interest when I saw that activist investor Elliott Investment Management had taken a roughly $4 billion stake in the company. Elliott has big ideas to make PepsiCo a huge turnaround story in the consumer-packaged goods ("CPG") space.
So in yesterday's e-mail, I analyzed PepsiCo's historical financial statements in the wake of this activist activity. As I concluded:
PepsiCo is an outstanding business that generates massive amounts of [free cash flow]. But I don't think the stock will move unless the company can show meaningful growth.
Could Elliott's ideas be a catalyst for this?
So today, let's take a look at Elliott's 75-page slide presentation on turning around PepsiCo...
Elliott starts with an overview of the company's many leading products and brands. Here's the overview slide (page 6):
You'll probably recognize most – if not all – of the brands Elliott listed. This is an iconic, global company.
The real gem here is the North American snacks business. It accounts for 30% of sales... but roughly 50% of profits.
However, Elliott argues that PepsiCo's stock price has significantly lagged its peers for two main reasons:
- "Persistent Share Loss and Margin Erosion in North American Beverages," and
- "Decelerating Growth and Declining Margins in North American Foods."
As a result, Elliott says this weakness in North America has made the company's overall organic growth and earnings suffer... despite strong performance globally.
Regarding the first reason...
In the slide below, Elliott shows how badly PepsiCo's North American beverages division has underperformed Coca-Cola (KO) and Keurig Dr Pepper (KDP). By now, Pepsi – once a formidable competitor to Coke – is now only the fourth best-selling soda behind both Dr Pepper and Sprite. Take a look (page 21)...
Compounding the volume decline, PepsiCo has grown corporate expenses and capital expenditures rapidly over the years. But this didn't result in much growth. As a result, margins have declined substantially. Here's how Elliott breaks it down (page 23):
For a while, PepsiCo's North American snacks business, 90% of which is Frito-Lay, made up the shortfall.
As Elliott says in this next slide, strength at Frito-Lay North America ("FLNA") meant that PepsiCo overall got a "pass" (page 22):
But growth at FLNA has slowed. And it actually turned negative last year. Here's Elliott's slide on this this (page 24):
What this chart doesn't show is that in recent years, FLNA has been relying on price increases to drive revenue growth.
For example, unit sales were roughly flat in 2022... meaning that all of the 17% "FLNA Organic Growth" was due to price increases.
This was unsustainable because it has generated pushback from consumers... and has created opportunities for competitors to steal market share.
So with growth stalled, investors have soured on the stock. As Elliott shows in this next slide, PepsiCo's price-to-earnings (P/E) multiple has contracted to the lowest level in more than a decade... and the stock trades for a substantial discount to its peers (page 7):
Elliott argues that the stock is "deeply undervalued." But it's not unless PepsiCo can start growing its revenues and profits.
So, what are Elliott's ideas for how to do this? Let's take a look...
Here's the summary in this next slide (page 31):
Elliott calls on PepsiCo to refranchise its bottler network. In the slide below, the firm says this is how things were from 1999 to 2010 when PepsiCo outperformed Coca-Cola (page 44):
Doing so would increase margins and result in a less capital-intensive business. But PepsiCo worries (rightly) that this would be a difficult and potentially disruptive process.
Elliott also wants the company to close or divest underperforming brands...
It gives a few examples in beverages to put under review: Starry, SodaStream, Bubly, and Mountain Dew Amp.
For similar examples in snacks/foods, Elliott lists a handful that PepsiCo acquired via Quaker Oats. These include Near East and Rice-A-Roni rice, Pearl Milling syrup, Life cereal, and Chewy granola bars.
As examples of what PepsiCo can do – and the share price gains that might come from it – Elliott cites Coca-Cola from 2017 to 2020 and Procter & Gamble (PG) from 2018 to the present. Here's the breakdown in this next slide (page 66):
So is Elliott correct that PepsiCo is the next "Great U.S. CPG Turnaround"?
I'm not persuaded.
For PepsiCo to be a winner, two things have to happen...
First, Elliott's plan has to be the right one to unlock value. And then Elliott has to successfully persuade the company to adopt the plan.
Regarding the former, PepsiCo's main problems are likely outside of the company's control.
PepsiCo is in a mature, low-growth business with fierce competition. It was able to show decent growth for a while by aggressively raising prices, but now that game is over. And there's a growing headwind from the new weight-loss drugs.
In addition, it's not clear that PepsiCo has been badly managed and is vulnerable to Elliott's pressure.
The share price performance has no doubt disappointed investors... but it's not so bad that they're mutinous.
A recent Wall Street Journal article captures the pressure on CEO Ramon Laguarta – but it doesn't lead me to believe that there are likely to be big changes. Here's an excerpt from the article:
PepsiCo Chief Executive Ramon Laguarta has spent much of his three decades at the company buying brands and building businesses, amassing a portfolio stretching from soda and chips to ice tea and tortillas...
PepsiCo has said it is confident in its strategy. Investors, bottlers and analysts are pushing Laguarta, who has helmed PepsiCo since 2018, to lay out his own vision and a clear financial plan for the company's brands.
The company said it regularly engages with shareholders to hear their views. "We are reviewing Elliott's presentation in the context of driving long-term shareholder value," PepsiCo said.
Lastly, the stock – which I said yesterday was trading at about 17.8 times this year's earnings and 16.8 times next year's – is below its peers' and historical multiples. But it's not cheap.
I think PepsiCo's stock will do fine from here. But "fine" isn't good enough.
I'm more interested in pound-the-table, trembling-with-greed ideas. And PepsiCo doesn't look like that today.
Here at Stansberry Research, that's what I'm looking to find with my team at our flagship Stansberry's Investment Advisory newsletter. Each month, we share our top idea. In fact, we released our latest monthly issue and new recommendation last week – subscribers can get all the details in the full issue.
If you aren't an Investment Advisory subscriber, learn how to become one – and gain access to this new recommendation, along with all of our other open recommendations – right here.
Best regards,
Whitney
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