PepsiCo Restructures
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PepsiCo Restructures
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(FOOL CONFERENCE CALL SYNOPSIS)* By Debora Tidwell (MF Debit)
PepsiCo, Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> UNION CITY, Ca., September 28, 1996/FOOLWIRE/ --- PepsiCo held a conference call with analysts yesterday morning to try to put their Thursday evening/Friday morning press announcement in perspective. While the numbers are big and important, they think much more important to the future of PepsiCo is the strategy. What they are doing is taking what has historically been a hugely successful corporation and positioning it to perform just as well as it has in the past, but much more consistently.
BACKGROUND AND WHERE THEY ARE TODAY
PepsiCo is in 3 worldwide industries that are huge and getting bigger all the time. They are in worldwide markets that add up to one half trillion dollars if you combine restaurants, beverages, and snacks. Moreover, everything about the demographics and economics tells them that these markets should be growing pretty rapidly as far as they can see. Within these industries, they dominate one of them and rank a very powerful second in the other two. Because of the vast scale of these businesses, combined with their strong market positions and powerful cash flow, they believe that they should be able to grow sales and profits at a rate in the mid-teens year-in and year-out for as long as they want to.
There is no absolutely fundamental issue that inhibits them from doing that and, historically, they have grown at those rates. Looking back at almost any period in PepsiCo's history, there has been compounded growth of about 15% with the notable exception of the last few years. There have been a number of highs and lows along the way. PepsiCo is taking actions to not only restore the historic growth rate they have enjoyed, but do it in a far more consistent and predictable manner.
Historically, they have been an extremely powerful generator of cash. In fact, in the last 5 years they have produced about $7 billion in operating free cash flow. That is a lot of cash. However, they think with their new strategies they should be able to do even better than that. For example, this year, despite the operating weakness in the international beverages, they should crank out about $1.8 billion in cash which is in line with what they expected for the year. Going forward they expect their cash to grow in the double-digit rate. That gives them a lot of flexibility to reinvest in their business, pay down debt, pay dividends, buy back stock, and more. So far this year they have bought back 41 million shares of PepsiCo stock and they expect to pick up the pace of the buybacks to around $2 billion per year going forward.
WHAT THEY ARE GOING TO DO
-- They are restructuring international beverages. Their intent is to take $100 million a year out of the operating costs of that business.
-- They are writing down their Baesa investment to what they believe is a prudent level, given the conditions that exist.
-- They intend to get rid of some non-core assets and will review a lot of others.
-- They are going to step up their successful restaurant refranchising program.
-- They intend to work hard to expand their snack food margins, especially in the United States.
-- They intend to have a domestic beverage business that continues to be as successful as it is today, whether measured in terms of market share, volume, profits, or cash flow.
-- They intend to have an international beverage business that is far more focused and far more streamlined with good predictable long-term growth.
-- They should have a US snack food business that will continue to grow from enormous successful base that it is already at and even more profitable than it is today as they improve margins.
-- They intend to have an international snack food business that will grow at a 20% plus rate year after year.
-- They see their restaurant businesses growing internationally at a very strong clip. There are huge opportunities overseas. And they see the restaurants being far less asset-intensive domestically.
-- Restaurants will be a core business that they can focus on.
-- They will take a $125 million charge in Q4 to restructure international beverages.
-- They will take a $400 million, mostly in Q3, to write down Baesa; to cover the exiting of several non-core businesses such as their plastic package ventures, coffee manufacturing venture, world trade ventures, etc.; and to recognize impaired assets in a number of joint ventures and franchise operations.
SPECIFICS ON THE BEVERAGE BUSINESS
Domestically, the beverage business is very powerful. Volume is strong. They are making a lot of money. Overall they are very pleased with their recent performance and think the future looks great. 90% plus of their profits come from their North American business. This year they will deliver about $1.4 billion in pre-tax profit and about $1 billion of operating free cash flow, a fairly rare combination. They will continue that gain in margins and returns. Their earnings for North America for Q3 and the full year will be up in mid double digits.
-- Domestically, they need to be more competitive and intend to be in certain areas, like fountain sales.
-- International beverages is clearly not in great shape. They explained that they "got out a little ahead of their headlights."
-- They think they can succeed in the international business. To do so, they feel they need to lower their operating costs, focus their efforts, and pay a lot more attention to the basics of the operating business (the bottling business).
-- They will pursue either a company-owned bottling approach or franchise bottling approach.
-- They will have few new joint ventures, and then only where there is absolute clarity on objectives, roles, and operating modes.
-- They think it would be a mistake to think of the international soft drink business as a constant sum game between themselves and Coke. Most of the time, they don't need to beat Coke to have a huge and growing business. There is a lot of market growth to come out there and a lot of places around the world.
-- They already have a strong position in a number of places, including the Middle East, and have what they consider a pretty level playing field in the huge and very attractive emerging markets of India, China, the former Soviet Union, Eastern Europe, etc.
-- They will concentrate on a few high-opportunity markets where they have a chance of building a very large-scale business.
-- They think their franchisees know how to grow and make money even when they are up against a strong #1 player in a lot of the other countries.
-- With regard to Baesa, they think that the strategic concept of an anchor bottlers is a pretty sound concept and certainly works for their competitor.
-- Baesa had been very successful in Puerto Rico and Argentina before adding Brazil to its territory.
-- Baesa invested too much too fast and got caught in an economic downturn and terrific competitive pressure. The financial structure was wrong.
-- They think Baesa got caught up in the allure of a vast and growing market, Brazil, which seemed better than it actually was.
-- Unlike Puerto Rico and Argentina, Brazil is an extremely tough place to make inroads. Consumers there have a lot of brand loyalty and they underestimated Coke's strength in Brazil. It wasn't a level playing field.
SPECIFICS ON THE SNACK FOOD BUSINESS
In the US they have created one of the great business success stories of all times. To a large degree, in the snack food category, Frito-Lay has become the industry. They faced an unusual opportunity when Eagle left the business. A fair chunk of market share was up for grabs and they decided to pursue it aggressively. They were successful and grew volume and share.
-- They did not grow the volume to quite the level they planned and not to the level to grow profits as much as they had hoped.
-- Costs got ahead of volume growth because of investments for the future such as adding a record number of new routes, inefficiencies related to ramping up volume quickly and ahead of volume. This will not continue into Q4.
-- They are continuing to invest in innovation for future growth as well as capacity investments for infrastructure and people.
-- At this stage they are in a great position to leverage the gains they have made and focus on expanding their margins.
-- Their US snack business is bigger and healthier than it has ever been.
-- The international snack food business is a dynamo that has been growing sales at close to 20% per year for 5 years and is not slowing down. It made $300 million last year and they don't see anything that should keep them from turning in solid, consistent growth for many years to come.
SPECIFICS ON THE RESTAURANT BUSINESS
Last year they announced a new strategy to reduce the ownership level they have of company-owned restaurants. This was for operating reasons and financial benefits. A local franchisee can operate a restaurant far better than they can. The licensing fees and royalties PepsiCo gets can be higher than the profit they were making by owning the restaurants themselves.
-- Although they are having a tough quarter in restaurants, their refranchising strategy is working and has been very effective.
-- They now believe they can franchise a large part of their system and still have very good control over marketing new products and all the things they do well.
-- They will make money by refranchising restaurants and they will have less exposure to the normal ups and downs that occur in the restaurant industry.
-- Competitive hot new products, pricing, or competitive actions have always meant big swings in same store sales.
-- When there was huge geographic expansion in the US, a lot of store building going on, those kind of swings were masked by distribution expansion. Recently, because PepsiCo owns so much of their system, they have been hit pretty hard by the marketplace dynamics.
-- They need to improve their marketing and their store operations.
-- They are reviewing casual dining and eliminating Hot and Now.
-- They are focusing on their core businesses and are putting their best people on the big things that really count. * A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. |
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Copyright 1996, The Motley Fool |