The New Economy has some weird dynamics that still take some getting used to. One is the divergence of the Nasdaq and the Dow. They're not perfectly diametrically opposed, but often enough they move in a way that looks like a correlation: When one is up, the other is down, and vice versa. Over the last couple of days, the Nasdaq has stumbled as tech stocks got another corrective beating. Not to worry, though, high tech still has plenty of fundamental value.
Which brings us to another peculiarity of the New Economy -- the way Old Economy stocks are often completely ignored, even when their basics are sound. Case in point: PepsiCo (PEP). It dropped pretty steadily from around 38 in early January to a 52-week low of just below 30 in the first half of March. In the last week or so, it has jiggled its way back up to its current price of 35 5/8. That's smack in the middle of its 52-week range, and the company's executives are worried about what this implies. "The average consumer-product company lost a quarter of its market value last year," says Pepsi CEO Roger Enrico. "That doesn't make me feel any good."
I'm with him. New Economy/Old Economy notwithstanding, Pepsi's lackluster performance doesn't make sense to me. I'll buy that (some) dot-coms are on the cutting edge of a technology that's going to revolutionize the way we communicate, and as such, have enormous potential that should be reflected in their stock prices. I'll buy that (many, not all) bricks-and-mortar companies need to come up with an Internet strategy or fall by the industrial wayside.
MISERABLE TREATMENT. But the Internet hasn't replaced the basic human urge to snarf Fritos and guzzle soda pop. If anything, judging by my own consumption patterns, the Net-related rise in the average worker's hours at the computer terminal has only increased the appetite for salty snacks and soft drinks. So why -- when the company has successfully restructured to leave itself with a dominant share of several markets with growth potential and high margins -- is Pepsi's stock being treated so miserably?
Two reasons. The obvious one: In New Economy investing, silicon is sexy, food is fusty. The not so obvious: It has taken a long time for Pepsi to give up its bad habits. Having watched with approval as it dumped both its bottling operations and its fast-food chains and revamped its marketing strategy to stop bellyflopping in Coke's strongest markets, investors are waiting for signs that Pepsi can consistently deliver the goods. Assuming it can, at its current price and with analysts targeting 12-month prices of 45 to 50 a share, the stock looks like a good buy.
"A lot of people think that Pepsi has its house in order," says George E. Thompson, a Prudential Securities analyst, who predicts PepsiCo stock will hit $50 a share within 12 months. "Now they are just waiting for the company to put impressive numbers up. I think that will happen."
"SUSTAINABILITY." Pepsi has disappointed in the past, but management now seems determined to redress these wrongs. "We started the restructuring with two things in mind," says Enrico. "One is to create consistency of performance, because we think shareholders value that. And the second thing is sustainability of marketplace performance."
Right now, Pepsi is in three basic businesses -- soft drinks, snack foods, and orange juice -- and it has impressive market performance in all three. With Frito-Lay, it has a 57% share in the snack-food market, and Tropicana gives it a 44% share of the orange juice market. Outside of fountain sales, which are a lower-margin business anyway, Pepsi is neck and neck with Coke in soft drinks. Together, these businesses yielded revenue growth of 6%, to total $18.7 billion in 1999.
That's a big snore when compared to dot-com sales growth, but Pepsi's single-digit revenue growth is translating to double-digit bottom-line growth. A lot of dot-coms are still looking forward to the day when they'll write their bottom line in black instead of red. Pepsi's total sales actually shrank with the divestiture of the fast-food division that included Pizza Hut, Taco Bell, and Kentucky Fried Chicken, but its net income rose.
Earlier this week the company said it was on track to hit 28 cents a share when it announces its first-quarter earnings on Apr. 19. That's down a bit from fourth quarter 1999's 33 cents -- which was a cent or two higher than everybody was expecting -- but right in line with analysts' projections.
NO PANACEA. For now, management's main concern is future revenue growth. Over the past year, it has been working hard to get supermarkets to adopt its "Power of One" marketing package. The idea is to put snacks and soft drinks together in the supermarket aisle. One raises a thirst, the other quenches it. Analysts think it's a good idea, although no panacea. "It's a good strategy, but it's tough to execute on because ultimately the retailer is not going to forget about Coke," points out Jennifer Solomon, beverages analyst at Salomon Smith Barney.
But she and other analysts admit the scheme will give Pepsi more clout in the supermarket. "[Power of One] will make a difference," says Prudential's Thompson. "It won't be a blow out in the first quarter, but it will create a steady increase [in sales] over the next few years."
One of the biggest growth opportunities is in the orange juice business, a small portion of Pepsi's total sales, but one that's benefiting from the trend in healthier eating in the U.S. Tropicana's year-on-year fourth-quarter profits rose 54%, to hit $54 million in the last quarter of 1999. Orange juice aside, with Aquafina, Lipton's Iced Tea, and Starbucks Frappucino, Pepsi has the top drinks in the bottled water, ready-to-drink iced tea, and coffee categories in the U.S. All of these products should get a boost next year when Pepsi's distribution agreement with rival Ocean Spray runs out. Then the Pepsi salesforce will be able to push Tropicana's line where it had been pushing Ocean Spray.
GLOBAL GEM. But it's outside the U.S. where Pepsi's real growth potential lies. In soft drinks, its strategy is to grow in markets where Coke isn't, like India, instead of banging up against its rival in its core markets such as Western Europe. The company has begun to focus on marketing efforts in Asia and Eastern Europe, but it may take some time before these new markets have a big impact on revenues. From 1998 to 1999, Pepsi's international revenues grew 6%, to hit $1.8 billion.
Frito-Lay should be the real gem of Pepsi's international portfolio. Especially strong in Latin America, Pepsi has upwards of 80% of the Mexican snack market with its brands Sabrita and Gamesa. Mexico accounts for about 50% of Pepsi's international revenues. Britain is second, contributing about 25% to Frito-Lay's non-U.S. revenues. Frito-Lay plans to keep building this business through a judicious international acquisition program.
Wall Street is fairly bullish on Pepsi's chances of finding a way to increase revenues, predicting 2000 sales of around $20 billion. For 2001, it's looking for growth of nearly 10% to hit $22 billion. That's going to translate into earnings per share of around $1.40 and $1.55, respectively. "There's plenty of opportunity in these businesses," says Prudential's Thompson. That means a buying opportunity for investors.
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2005, by The McGraw-Hill Companies Inc. All rights reserved.
