If you’ve been reading the Wall Street Journal, you’ve seen the commotion. Peltz – of Trion Fund Management – is pushing a merger between PepsiCo, Inc. (NYSE:PEP) and fellow snack maker Mondelez International Inc (NASDAQ:MDLZ), followed by a spinoff of PepsiCo, Inc. (NYSE:PEP)’s weaker beverage business.
Here is why I think the plan has potential, and how it could be better.
Snacks drive profits
PepsiCo, Inc. (NYSE:PEP) markets more than just beverages. In fact, only half of Pepsi’s $65 billion revenue in 2012 came from drinks. The rest came from its snack division. In 1965 Pepsi merged with Frito-Lay, giving it one of the largest snack brand portfolios in the world. Do you like Doritos, Lays, Cheetos, or Sunchips? Each of those snacks is made under Pepsi’s roof, plus many more.
In the second quarter, Pepsi reported earnings of $1.28 per share, up 36% from $0.94 a year ago and beating Wall Street expectations of $1.19. According to Pepsi CFO Hugh Johnston, its variety of products helped the firm remain strong despite the unusually chilly quarter that saw rival The Coca-Cola Company (NYSE:KO)’s earnings go backward.
The Coca-Cola Company (NYSE:KO), which gets 100% of its revenue from beverage sales, saw earnings decrease by 4% to $0.59 per share in its second quarter. Coca-Cola blamed the slide on cold weather lessening consumers’ taste for cold soda. Specifically, North American soda sales fell by 4%, continuing an eight-year downward trend of soda consumption in the region. Pepsi however, was able to rely on its snacks to power through the cold quarter.
Why Mondelez?
A merger between Pepsi and Mondelez International Inc (NASDAQ:MDLZ) would create a snack giant with quarterly revenue upwards of $21 billion. Such a company would be unmatched in size and market share in the global snack industry. Furthermore, the merger would enable Pepsi to further distance itself from Coca-Cola’s woes in U.S. beverage sales.
In the first quarter of this year, Mondelez International Inc (NASDAQ:MDLZ)’ grew revenue by .9% to 8.7 billion, which included 9.3% revenue growth in emerging markets. In addition, Mondelez posted gross profits of $3.2 billion up by 1.5% from the year before. This means snack consumption isn’t decreasing with soda consumption. Consumers appear happy to enjoy chips and cookies while skipping a cold soda.
I’ve heard concerns that by acquiring Mondelez International Inc (NASDAQ:MDLZ), Pepsi would be competing with itself. However, that would not be the case as Mondelez’ lineup consists heavily of cookies (Oreos and Chips Ahoy! for example) and other candies and sweets. Mondelez International Inc (NASDAQ:MDLZ) does make some snacks (mainly Nabisco products) but the firm would complement Pepsi more than cannibalize it.
Keep the drinks
Should PepsiCo, Inc. (NYSE:PEP) get rid of beverages? I say no. Pepsi should compromise, by buying Mondelez International Inc (NASDAQ:MDLZ) while still keeping the beverage unit. Yes, the America’s Beverage unit is underperforming, but the segment represents almost a third of Pepsi’s revenue.
In 2012, Pepsi’s American beverage segment comprised 33% of revenue, along with 28% of profits. That’s down from 2011 when the unit made up 34% and 30% of revenues and profits, respectively. In contrast, the America’s Food unit contribution to the bottom line increased over the last year. In 2012, the segment supplied the bulk of both revenue and profits with 37% and 52%, respectively, up from 35% and 51% in 2011.
Source: PepsiCo.com
The declining sales of the America’s Beverage unit are largely a result of recent changes in consumer diets. These changes have consumers making healthier decisions that leave out sugary soda and juice.
But the changes aren’t overwhelming, nor are they worldwide. Pepsi is still making gains in its beverage unit elsewhere in the world. Divorcing beverages would be like taking a slice of pie that’s simply too big to eat. If the unit continues to shrink, spinning off the America’s Beverage segment could be a possibility, but the current decline isn’t severe enough to warrant such a brash measure.
Bottom line
Snacks are the future of Pepsi. With greater demand, snacks have a larger upside than beverages. Still, drinks are a large chunk of Pepsi’s top-line, so a spinoff at this point wouldn’t be wise. Pepsi should keep an eye on its America’s Beverage unit while capitalizing on global opportunities that exist in soda; mainly in emerging markets.
PepsiCo, Inc. (NYSE:PEP) and Mondelez International Inc (NASDAQ:MDLZ) should merge, but Pepsi shouldn’t spin off its beverages just yet. There’s still money to be made.
The article PepsiCo and Mondelez? Yes Please. originally appeared on Fool.com and is written by Marie Palumbo.
This article was written by Randy Holcombe and edited by Chris Marasco. Chris Marasco is Head Editor of ADifferentAngle. Neither has a position in any stocks mentioned.The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of PepsiCo. Marie is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
