Looking for a Pepsi rebound

by L. Joshua Sosland
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A difficult third quarter at PepsiCo, Inc., particularly the company’s Americas Beverages business, makes clear why the company is intently focused on improving results in what is the largest division at the company in its current reporting structure.

By most measures, Pepsi Americas Beverages was the worst performing unit at PepsiCo during the quarter ended Sept. 8. Volume for the segment fell 3%, while the remainder of PepsiCo’s divisions achieved positive volume growth, save Europe, off 1%. Net revenue, down 6% on a core basis, was worse than five of the six other segments. Core operating profit, down 15%, underperformed every other PepsiCo segment — Frito-Lay North America, Latin American Foods, Quaker Foods North America, Europe and Asia, Middle East and Africa (AMEA).

Overall, operating income for the Americas Beverages division was $837 million in the third quarter ended Sept. 8, while revenues were $5,530 million.

The lower operating profit was attributed principally to higher commodity costs as well as elevated advertising and marketing expense. The impact of the higher costs was partly blunted by favorable effective net pricing and savings resulting from productivity initiatives, the company said. Costing the segment 2 percentage points in operating profit performance was a refranchising of the division’s Mexican beverage business.

The revenue decline represented a reversal from the second quarter when net revenue was higher, bolstered by strong pricing and good performance in small format and wholesale club channels. At the time, PepsiCo leadership was upbeat about its strategies.

“We remain highly disciplined in the execution of our price pack and channel strategies, and as a result, we are seeing very good performance in the immediate consumption packages, which led to strong net revenue growth in the C-store channel and we are seeing good, stable value per share performance relative to our primary competitor in measured channels,” said Indra Nooyi, chairman and chief executive officer, after the second-quarter results were issued.

The performance arc of a vaunted new product, largely mirrors how the division has done overall as 2012 has progressed. The Next brand was introduced in March, described by Pepsi as “a game-changer in the cola category,” the first product “to deliver real cola taste with 60% less sugar than Pepsi-Cola.”
In a spring conference call, Ms. Nooyi described Pepsi Next as “off to a strong start.”

As the year has progressed, enthusiasm about the brand showed some signs of waning. In June, Al Carey, c.e.o. of Pepsi Beverages Americas said he felt “pretty good” about Pepsi Next, noting that it was ahead of goal a couple months after the launch, accounting for just under 1% of the entire carbonated soft drink business.

“Trial and repeat are tracking a little bit ahead of the test market,” he said, speaking at the Deutsche Bank Global Consumer Conference. “We have kind of round two of advertising and campaign that starts in July 1. So I feel very good about this product. It tastes very much like regular Pepsi. And some people say, well, you launched the Pepsi Edge 10 years ago. It was a mid-calorie cola. Why is this different? Because of the taste. It’s significantly different and I’m a regular Pepsi drinker.”

Expectations were tamped down just a bit further in July after second-quarter earnings were issued.
“We have Pepsi Next in the marketplace that is delivering about what we expected,” Ms. Nooyi said. “(We are) very happy with it, and in the just recent few weeks we’ve just launched a new TV campaign and also two new flavors of the product. So let’s say (we are) cautiously optimistic on that brand.”

By the time the third-quarter earnings were issued last week, the Next brand barely merited a mention, listed passingly, if optimistically, among a series of new products Ms. Nooyi said have continued to “steadily build” in recent months.

Still, the carbonated soft drink business has had several bright spots in 2012. At the Deutsche Bank conference, Mr. Carey highlighted Mountain Dew for its promise.

“Mountain Dew is a brand that has probably got significantly more potential than anything in the shop,” he said. “It stands for exhilaration and it is the theme is it is what we do and it’s brought to life through action sports. This brand is all about young men between 16 and 32, 34, and it’s a lifestyle product.”

Targeting this demographic with a campaign featuring celebrities popular with teens, Mr. Carey said Mountain Dew has been positioned as “the safe energy drink and it plays in that space.”

In the period leading up to his presentation, Mountain Dew sales were up 6%, which Mr. Carey described as a “big number.”

More broadly, Ms. Nooyi was positive about the carbonated drink business after their third quarter results were issued.

“Based on the IRI all-channel data, we gained both value and volume share in the quarter,” she said. “So, even with higher pricing at retail, we grew our volume share. Our brand equity scores are strong, and our brand-building investments are working.”

On the other hand, the noncarbonated business, which had been the stronger piece of the Pepsi beverage portfolio in recent years, did not do well.

“Our noncarbonated beverage performance in North America was more challenged, driven by three factors,” Ms. Nooyi said. “First, we cleaned up our juice portfolio by pulling out of unprofitable juice drinks. Second, we made deliberate decisions not to compete in case-pack water at unprofitable pricing levels. And third, Gatorade’s performance was off this quarter, which is really a function of competitive pricing actions and an inventory outage at one of our major accounts. Q4 is off to a good start, and we expect the business to be positive for Q4.”

Mr. Carey tagged Gatorade as the “big drag in Q3.” He said the brand already has begun to show signs of revival in the fourth quarter, driven by a three-prong strategy of main-taining a reasonable everyday low price, effective advertising and product news.

“We have plans next year for improved product news on the base Gatorade business that I think will add some growth,” he said.

Ms. Nooyi also was optimistic about Gatorade, suggesting a significant part of the weakness was “an inventory problem at a certain customer.” She remained steadfast in her commitment to the company’s strategy for building the brand.

“As we go into Q4, we are already into positive territory and again what we want to make sure in Gatorade is that we don’t make the mistakes that we made in the 2004, 2005, 2006 time frame where we grew it as a general hydration product as opposed to a sports nutrition product,” she said. “Because if we go back to that strategy of just selling it as an everyman’s hydration, and just another beverage, we are again renting volume. We’ve been there, done that. So we want to make sure we’re going after the active, going after the athlete, sustaining our pricing and flanking our core Gatorade product with innovation.”

Tingyi partnership poised for flight
PURCHASE, N.Y. – An upbeat outlook for PepsiCo’s new strategic beverage alliance in China was voiced by Indra Nooyi, chairman and chief executive officer of PepsiCo, Inc., in a conference call with investment analysts.

Ms. Nooyi spoke Oct. 17 in a call following the release of third quarter financial results. In March, PepsiCo completed the transaction forming an alliance with Tingyi (Cayman Islands) Holding Corp., a leading food and beverage company in China. Under the deal, Tingyi’s beverage subsidiary – Tingyi-Asahi Beverages Holding Co Ltd. (TAB) has become PepsiCo’s franchise bottler in China. The country is expected to become the world’s largest beverage market by 2015.

In the call, Ms. Nooyi said the Tingyi integration is “substantially complete” and that volume growth has grown steadily since June.

Still, Ms. Nooyi said the fastest growth is still to come.

“We haven’t yet started to reap the benefits of the increased Tingyi manufacturing footprint because we haven’t yet pulled the cold fill lines in the new Tingyi plant,” she said. “So, the benefits you are seeing now is just a benefit from our own brand equity.”

The potential for the partnership is extraordinary, Ms. Nooyi said.

“The alliance between PepsiCo and Tingyi creates the largest beverage company in China with a 1.5 to 1.6 relative market share versus the next largest competitor,” she said. “Between us, we will basically cover the entire country and have over 70 plants (versus 20 before the alliance) between the two of us in China. So, I think 2013 and forward this business is going to look very, very good.”

More generally, Ms. Nooyi said she is optimistic about the business outlook for China. Responding to a question, she said she has been there three times this year and would be returning still again this month. The slowdown in economic growth is a significant issue in the country but should not be overblown, Ms. Nooyi said.

“From a consumer product perspective, especially on small ticket items which are very basic food and beverage products, you don’t really see the impact in our categories,” she said. “And, in every city that I have been in China, and I’ve crisscrossed the country, there is buoyancy. There is a certain optimism in the country. Of course, everybody would like the growth to go back to 9% or 10% in China, but at 7.8%, I still think China is performing at the peak of its game versus all the other countries in the region, or in the world today.”

Beverage still tops at Pepsi…barely
While it has not grown as quickly as its food business, the importance of beverages globally at PepsiCo remains considerable. In the company’s 2011 annual report, Indra Nooyi, chairman and chief executive officer, noted that drinks accounted for about 52% of sales in 2011 and are a “highly profitable” part of what PepsiCo, Inc. does.

“Our goal is to grow our developed market beverage business while building on promising gains in emerging and developing markets,” she said. “We intend to continue to invest in and strengthen our most powerful and iconic beverage brands.”

The company’s brands include Pepsi, Gatorade, Mountain Dew, Diet Pepsi, Aquafina, 7UP (outside the U.S.), Diet Mountain Dew, Tropicana Pure Premium, Sierra Mist and Mirinda, and Pepsi Americas makes, markets, sells and distributes these brands as beverage concentrates, fountain syrups and finished goods, operating either independently or through contract manufacturers.

Also independently or through contract manufacturers, Pepsi makes, markets and sells ready- to-drink tea, coffee and water products through joint ventures with Unilever (under the Lipton brand name) and Starbucks. The company licenses the Aquafina water brand to its independent bottlers. Finally, the company manufactures and distributes certain brands licensed from Dr Pepper Snapple Group, Inc., including Dr Pepper and Crush. The company operates its own bottling plants and distribution facilities. In February 2010, the company acquired its anchor bottlers, The Pepsi Bottling Group, Inc. and PepsiAmericas, Inc.

Even as the division has struggled, Pepsi Americas Beverages is the largest segment at the company, accounting for 34% of revenues in 2011 (Frito-Lay North America and Europe rank second, accounting for 20% of revenues each), 30% of operating profit (Frito-Lay is more profitable, 33%), 43% of assets (Europe is second, 25%) and 30% of capital spending (Asia, Middle East & Africa is second, at 21%).

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