BUSINESSWEEK ONLINE : FEBRUARY 15, 1999 ISSUE
COVER STORY

Can Gen Yers Down Enough Mountain Dew to Lift Pepsi's Stock?
After a disappointing, "transitional" 1998, some analysts think the revamped company could sparkle again soon

As a leading maker of soda and snacks, PepsiCo (PEP) seems poised to benefit from the approaching wave of 60 million teenagers who'll roll through the economy in the next decade or so. Already, Generation Y clamors for the company's caffeine-charged Mountain Dew soft drink.

Indeed, strong Mountain Dew sales for the second straight year were one of the bright spots in the company's Feb. 1 earnings release. However, that was one of the few bright spots.

PepsiCo reported fourth-quarter net profits of $361 million, or earnings per share of 24 cents -- a 20% decline from 29 cents for the fourth quarter a year ago. Net sales climbed to $7.2 billion in the quarter, up from $6.3 billion in the fourth quarter of 1997. The combination of higher advertising and marketing expenses, primarily to launch low-cal Pepsi One and the Wow! line of Olean-based chips, ate into profits -- as did a weak global environment. In the conference call with analysts that followed its earnings announcement, PepsiCo warned that first-quarter 1999 results could be hurt by economic woes in Brazil.

After a volatile 1998, in which the stock traded as high as 45 in April and as low as 28 in August, PepsiCo shares have ended up in the same high-30s trading range where they were 18 months ago: The stock closed Feb. 4 at 38 1/16, down 3/4.

"A NEW ERA"? The lackluster earnings and stock performance are trying the patience of investors who expected Chairman Roger Enrico's strategy for overhauling the company to improve bottom-line results by now. Enrico has focused Pepsi on its core beverage and Frito-Lay snack business: In 1997, it spun off its restaurant division into Tricon Global Restaurants (YUM), and it will soon spin off its bottling business. PepsiCo acquired Tropicana juices from Seagram Co. for $3.3 billion in cash last July and also made several investments in snack products in international markets, including Europe and Australia. "The year 1998 was a transitional one," summed up Merrill Lynch analyst Emanuel Goldman in a Feb. 4 report that raised the question in its title: "A New Era for Pepsi?" He continues to rate the stock a buy.

"We're trying to be patient with the stock," says Jay Sekelsky, lead equity manager for Mosaic Funds, who concedes that he expected to see better performance by now. He bought the stock about a year ago, and it has climbed only about 10%, while the S&P 500 has gained nearly 30% over the same period. "We thought results from the fourth quarter of 1998 would be a launch pad," he says. "Now we think it will be more like the second half of 1999, where we'll really see the acceleration in growth. That's what we're betting on."

Some Wall Street analysts still rate PepsiCo among their favorite stocks, because they believe that the turning point is nigh. "We're at an inflection point where after two years of going through a strategic overhaul of its business, the company will emerge in 1999 as a much stronger organization," says Skip Carpenter, an analyst with Donaldson, Lufkin & Jenrette.

FORGET COLA WARS. PepsiCo did have positive news in 1998, even if the earnings weren't sparkling. The company repurchased nearly 60 million shares, and it could use proceeds from the spin-off of its bottling operations to buy back more, analysts say. Soft-drink sales volume grew 10% in North America in the fourth quarter, thanks to sales of Pepsi One, Mountain Dew, and the bottled water Aquafina. Its 1998 soft-drink volume gain of 6% was the company's largest in four years, points out Goldman. Pepsi-Cola also gained market share against rival Coca-Cola. Coke now claims 37.1% of the soft-drink market vs. Pepsi's 31.7%, meaning that Coke's lead of 5.8 percentage points a year ago has narrowed to a 5.4-point spread.

As much as investors love to compare Coke and Pepsi, the cola wars aren't that important to the overall investment scenario, says Carpenter. Although Pepsi's sales of beverages and snacks were roughly equal last year, Frito-Lay generates nearly 70% of the company's operating profits. "Global snack food is what will ultimately carry, drive, and continue growth for the company for the long term," he adds. Frito-Lay already dominates the market in salty snacks, with a 55% share, according to Merrill Lynch. But even Carpenter concedes that unless PepsiCo's new products and new focus translate soon into strong earnings growth, he may have to temper his positive outlook.

By Amey Stone in New York

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