History of PepsiCo Company - Case Study Example

PepsiCo Inc was founded in 1965 through the merger of two companies – Pepsi-Cola and Frito-Lay. At that time the products of Pepsi-Cola were Pepsi-Cola, Diet Pepsi and Mountain Dew while those of Frito-Lay were Frito’s corn chips, Lays potato chips, Cheeotos brand cheese flavored snacks, Ruffles brand potato chips and Rold Gold brand pretzels (Company website). Today it is one of the world’s top consumer products company. It employs approximately 168,000 people worldwide and sells its products in 2300 countries. It has the second largest soft drink business in the world having 21 percent share of the world market and 29 percent share of the US market (Funding Universe, n.d.). They are also the world leader is the salty snacks division having 40 percent of the market share in the world market and 56 percent in the US. The group has another division known as Tropicana Products which is the world leader in juice sales having 41 percent share of the chilled juice market. In addition they also have the Quaker food and each division has its own product line and its own international market. Globally with all their products and brands, the company PepsiCo generates more than $500 million in sales each year and 35 percent of its retail sales are from outside the US. Pepsi had commenced international sales in the 1950s but Coca-Cola (coke) continued to be global market leaders. The company underwent massive restructuring after Roger Enrico took over in mid-1990s. The company started concentrating on unsaturated and emerging markets like India, China, Eastern Europe and Russia where Coke was not very aggressive. In these countries PepsiCo started relying on bottling joint ventures and Pepsi-owned bottling operations. PepsiCo entered the sports drinks market when it acquired Quaker Oats in 2001. This company had the Gatorade brand which held 83.6 percent of the US retail market in sports drinks. This acquisition made PepsiCo the world leaders in the fast-growing noncarbonated beverage category. Soon the company had an entirely new management team and they became formidable challenger to the arch-rival Coca-Cola. In April 2008, PepsiCo acquired the V Water, a vitamin water brand in the United Kingdom (MSN, 2008). The company is traded principally on the New York stock exchange and is also listed on the Chicago and Swiss stock exchange. The company has consistently paid cash dividends since the corporation was founded (company website). The company has five large-scale distribution systems (Cartagena, Demetropoulos & Martin, 2003). They have: a. The Direct-Store-Delivery through which they are able to reach more than 2 million retail customers each week. b. Broker-warehouse that moves Quaker, Gatorade, and Tropicana products to large retail outlets at a lower cost. c. National distribution system that focuses on foodservice and vending accounts. d. "Chilled" Direct-Store-Delivery system which distributes products requiring refrigeration. e. Hybrid system that enables PepsiCo to reach large numbers of retailers in emerging markets like India and China. Profit in the soft drink industry is solid but due to saturation in the market a deceleration of growth is expected. Product diversification is expected to contribute to the profit margins. Financial statement analysis of PepsiCo is difficult only for the soft drink division because over half their profits are from snacks or other beverage items. These sales figures grew from almost $16.5 billion in 2003 to $18 billion in 2004 and their operating profit margin also increased 1% from 2003 to 2004 (Deichert et al., 2006). The increase could be due to increase in the market share and there has also been a growth of the non-carbonated beverage market. Financial analysis also helps to understand the creditworthiness of a company. It helps to analyze whether a firm will be able to pay its obligations or it is under financial distress. The net profit margin of PepsiCo improved over time. The net profit margin measures the company’s ability to manage its expenses. PepsiCo relies to a great extent on debt financing and hence its debt to equity ratio is high. The debt equity ration was 18 percent in 2004 (Drake, 2005). Its debt to equity ratio has always been higher than industry average and even in June 2008 it was 36.35 against the industry average of 23.19 (Reuters, 2008). The debt ratio of a company is calculated as the sum of all the liability accounts divided by ‘total assets’. PepsiCo’s debt to equity ratio is higher then the competitors which denotes that it uses more financial leverage in the firm and is exposed to more financial risk. The company is exposed to certain market risks that include interest rates on debt and short-term investment portfolio, foreign exchange rates and other international market risks, and commodity prices that may affect the cost of raw materials (PEP, 1998). PepsiCo takes care of the debt and investment portfolios by balancing investment opportunities and risks, tax consequences and overall financing strategies. They reduce the overall borrowing costs by using currency swaps to modify the interest rates. Their investment portfolios consist of cash equivalents and short-term marketable securities. They hold their investments to maturity thereby gaining the maximum benefit. The company has huge international operations and carries risks in currency fluctuations but they do not hedge translation risks because they reinvest international cash generation locally. PepsiCo’s return on equity has remained the same over the 1995-2004 period. Return on equity (ROE) is calculated by dividing net income by the share holders’ equity. Its five year average has been 33.55 against the industry average of 12.81 (Reuters, 2008). Its return on investment has also been consistently high (21.47) and higher then the industry average (9.77). For the quarter ended June 2008, the company’s return on equity has been 43.98% which is a remarkable change over 2007 when the return on equity was 34.46 percent (Google Finance, 2008). Five year average of ROE has been 31.9% (Forbes, 2008). The higher the number the higher the returns the company is generating for its shareholders. Its high return on equity denotes high profit margin, effective use of its assets and use of leverage. The asset turnover ratio indicates a company’s ability to generate profits. This is calculated by dividing the sales by total assets. It shows how effectively the company is able to generate sales from its asset base. The asset turnover ratio is higher of the company is effective in generating sales. As of March 2008 the asset turnover ratio was 1.2 (Forbes, 2008). A company’s overall cost of capital reflects the combined costs of all the sources of financing used by the firm. The weighted average cost of capital is the after-tax costs of each of the sources of capital used by a firm to finance a project where the weights reflect the proportion of total financing from each source (Fagan, 2006). The firm has to earn this rate from its investments so that the investors and creditors can be compensated with their individual rates of return. Hence WACoC = (After tax cost of debt X proportion of debt financing) + (Cost of equity X proportion of equity financing). As far as PepsiCo is concerned, they calculate the cost of capital division-wise. They have different target ratios for debt equity again division wise and hence pretax cost of debt separately for each division. Accordingly the following chart shows the WACoC for PepsiCo: Division Cost of Cost of WA Equity X Debt X CoC ratio ratio Restaurant (12.20 X .7) (5.54 X .3) 10.20 Snack Foods (11.56 X .8) (5.23 X .2) 10.29 Beverages (11.77 X .74) (5.28 X .26) 10.08 It can thus be surmised the WACoC of PepsiCo remains around 10.20 even if all the divisions are considered as a whole. Quarterly cash dividends are paid since PepsiCo was formed in 1965. PepsiCo offers its shareholders dividend re-investment plan which is an automatic, inexpensive way to acquire additional shares of the company. A shareholder can reinvest all or a portion of his capital stock dividends and optional cash investments twice a month from a minimum of $25 to an annual maximum of $60,000 (PepsiCo, 2008). This plan is convenient, automatic and entirely optional and only those who have at least 5 shares are eligible to participate. As additional benefit to the investor, the company absorbs all bank service charges and brokerage commissions so that the total amount is an investment as far as the investor is concerned. This scheme is beneficial to the company as its overall debt is reduced if it can raise money by equity thereby reducing its cost of capital. This is the reason why PepsiCo has a high profit margin and its return n equity and WACoC is higher than industry average. At times companies have to take on excessive debts and artificially increase its ROE. Equity multiplier is a measure of financial leverage and an investor is able to judge what portion of the ROE is a result of the debt. This is calculated by dividing the assets by shareholders’ equity. Based on the figures available, the following ratios have been calculated to analyze the company’s financial position. * Revenue: $39474 (Hoovers 2008) * Net Income: $5658 (Hoovers, 2008) * Assets: $34, 628 (Hoovers, 2008a). * Shareholders’ Equity: $17, 234 (Hoovers, 2008a). Net Profit Margin: Net Income ($5658) ÷ Revenue ($39,474) = 0.1433, or 14.33% Asset Turnover: Revenue ($39,474) ÷ Assets ($34,628) = 1.1399 Equity Multiplier: Assets ($34,628) ÷ Shareholders’ Equity ($17,234) = 2.0092 Based on these figures the return on equity = Return on Equity: (0.1433) x (1.1399) x (2.0092) = 0.3281, or 32.81% A 32.81% return is very good return for any industry but if the equity multiplier is left out just to see how much PepsiCo would earn if it were completely debt-free, the ROE would be 16.33%. This implies that almost half of the ROE is due to the debt that is at work or involved in business. In addition, the liquidity position of the company is also good. This is understood by calculating the current ratio. The current ratio is determined by dividing the current assets (10,151) by current liabilities (7,753) or 1.3092 which is considered good. Liquidity is necessary meet expected and unexpected cash demands. Inadequate liquidity can stunt growth and then lead to downfall. An analysis suggests that PepsiCo is financially healthy and among the industry leaders in financial performance. It uses the currency swap strategy to manage its debts and investments and thereby also reduce overall borrowing costs. Thus any risks can be offset by the any opposite market impact on the debt. The analysis implies that PepsiCo is poised for growth and will be able to sustain competition. References: Cartagena, K. Demetropoulos, D. & Martin, T. (2003). PEPSICO CORPORATION STOCK ANALYSIS. Available from: http://www.stjohns.edu/media/3/80dc682a41f44209b5da9de5f8ac8bec.pdf [accessed 28 July 2008] Deichert, M et al., (2006). Industry Analysis: Soft Drinks. Available from: http://www.csbsju.edu/library/local/5thYear/zeigler_paper.pdf [accessed 28 July 2008] Drake, P. P. (2005). Financial Analysis. Available from: http://peregrin.jmu.edu/~drakepp/principles/module2/fin_analysis.pdf [accessed 28 July 2008] Fagan (2006). Cost of Capital. Ch 11. Available from: www.raritanval.edu/departments/busadmin/full-time/Fagan/BUSI%2520192%2520Powerpoints/ch11.ppt [accessed 28 July 2008] Forbes (2008). PEPSICO INC (NYSE: PEP) | Ratios and Returns. Available from: http://finapps.forbes.com/finapps/jsp/finance/compinfo/Ratios.jsp?tkr=PEP [accessed 28 July 2008] Funding Universe (n.d.). PepsiCo, Inc. Available from: http://www.fundinguniverse.com/company-histories/PepsiCo-Inc-Company-History.html [accessed 28 July 2008] Google Finance, (2008). PepsiCo, Inc. Available from: http://finance.google.com/finance?q=NYSE:PEP [accessed 28 July 2008] Hoovers (2008a). PepsiCo Balance Sheet. Available from: http://www.hoovers.com/pepsico/--ID__11166,period__A--/free-co-fin-balance.xhtml [accessed 28 July 2008] Hoovers (2008). PepsiCo Income Statement. Available from: http://hoovers.com/pepsico/--ID__11166,period__A--/free-co-fin-income.xhtml [accessed 28 July 2008] MSN (2008). Money Central. Pepsico Inc: Company Report. Available from: http://moneycentral.msn.com/companyreport?Symbol=pep [accessed 28 July 2008] PEP (1998). Managements Discussion and Analysis. Available from: http://www.pepsico.com/PEP_Investors/AnnualReports/98/financial/analysis.html [accessed 28 July 2008] PepsiCo, (2008). Dividend Reinvestment Plan. Available from: http://phx.corporate-ir.net/phoenix.zhtml?c=78265&p=irol-dividend_reinvestment_plan-general_info [accessed 28 July 2008] Reuters (2008). Pepsico Inc (New York Stock Exchange). Available from: http://www.reuters.com/finance/stocks/ratios?symbol=PEP.N&rpc=66 [accessed 28 July 2008] company website: http://www.pepsico.com/PEP_Company/History/index.cfm# Read More