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February 10, 2012

In the spotlight – PepsiCo’s plans beg more questions

After six months of criticism and speculation, PepsiCo has drawn up plans it believes will drive growth at the company. However, as Michelle Russell writes, although key questions have been answered, the measures have led to more being put to the US food and beverage giant.

After six months of criticism and speculation, PepsiCo has drawn up plans it believes will drive growth at the company. However, as Michelle Russell writes, although key questions have been answered, the measures have led to more being put to the US food and beverage giant.

PepsiCo’s new “strategic priorities”, a set of measures designed to drive growth, have garnered a mixed reaction from industry observers who question whether the plans will reap the benefits the US food and beverage giant desires.

The plans follow months of speculation about the future direction of PepsiCo. Analysts have agitated for the business to split in two to generate more value for the shareholders. They have also claimed that PepsiCo’s push into healthier categories has led it to pay less attention to its core snacks and fizzy drinks operations.

Yesterday (9 February), PepsiCo formally responded. It will remain one company and spend more on advertising, improve productivity and cut US$1.5bn in costs, the last of which will lead to 8,700 people losing their jobs.

Speaking to reporters in New York, Nooyi was forced to answer questions over whether PepsiCo might revisit the idea of splitting the business if the review did not have the desired results.

She told analysts that the idea of splitting the company in two has been “taken off the table”.

Morningstar analyst Thomas Mullarkey believes that Nooyi’s “strong reaffirmation” of PepsiCo’s commitment towards remaining an integrated food and beverage company means a split is now unlikely.

Mullarkey said the PepsiCo chief, who has faced speculation over whether she should remain at the company, believes the group “financially and operationally benefits” from its Power of One strategy, which was devised last year to bring its food and drink operations in the US closer together.

“She estimates that Pepsi achieves approximately $1bn per year of synergies by keeping both food and beverage operations under the same corporate roof,” Mullarkey said.

PepsiCo’s marketing plans will see the majority of the $500-600m extra expenditure spent on its core carbonated soft drinks and snacks businesses in North America. Nooyi, however, insisted that the company would continue to invest in its “good-for-you” business. “We are working across the whole spectrum. This is an ‘and’ game and not an ‘or’ game,” she said.

However, beyond the fact that PepsiCo is to remain one company, the apparent commitment to healthier products and the headlines around cost cuts, job losses and hike in advertising spend questions still remain about the detail despite Nooyi fielding questions on every aspect of the review yesterday.

The company has failed to give any specific details on which countries or divisions would feel the impact of the job cuts or which brands will benefit from the increased marketing spend.

Moreover, analysts at Bernstein questioned why PepsiCo had now decided to reorganise its business.

“Although you stated that ‘now is the time’ to take these actions because you have more ‘visibility’ to the future, is that really the case?,” the analysts wrote in a note to clients today. “Did your embarking on this business review have nothing to do with recent disappointment, poor stock performance – particularly relative to your peers – and frustrated investors?”

And other announcements led to further questions from Bernstein. PepsiCo announced it was targeting “long-term high-single-digit core constant currency EPS growth”. Bernstein analysts claimed the target was “little different than prior long-term targets despite a 2012 EPS base that will revert lower than 2010 levels based on company guidance”.

They added: “Is this the kind of return on investment investors should expect from an initiative that eats into two-plus years of profit growth? We suspect PepsiCo will have to answer this question as 2012 develops and PepsiCo’s reinvestment plans take shape.”

Mullarkey added that, as a result of the company’s increased investments, higher raw material costs, and a strengthening US dollar, slightly offset by productivity gains, he expected PepsiCo’s 2012 core EPS will be “8% lower than the $4.40 per share the company earned during 2011, in line with management’s forecast”.

“We plan to adjust our model based on fourth-quarter results, the softer 2012 outlook, and management’s strategic plan, which will take our fair value estimate to $72 from $76,” he added.

Bernstein said it is looking for PepsiCo to clarify a number of items related to its business outlook to “help foster receptivity among investors”.

And, looking at PepsiCo’s share price since its long-awaited announcement, it is unclear whether investors believe the plans will revitalise the business. PepsiCo’s stock was down 0.78% at $63.77 after a 3.8% fall yesterday.

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