Can PepsiCo turnaround the performance of its North American beverage segment?

• What led to the consistent decline of PepsiCo’s trademark drinks in the last few years?
• Can the recent improvement in top-line numbers for PepsiCo’s beverage segment be maintained in the long-term?

PepsiCo is the world’s second-largest food and beverage company. Its top line, as well as profitability, has been consistently growing over the last few quarters. The company has beaten the Wall Street’s estimates on each of its quarterly results in 2018 and is on the track to beat the yearly forecast as well

This continuous growth in the group level revenue and margins were driven by incessant growth largely by all segments. The below graph depicts the segment level performance of the PepsiCo for the last few quarters.

Frito-Lay North America (FLNA) and Europe Sub-Saharan Africa (ESSA) were the best performing segments, particularly, in terms of the revenue growth. FLNA and ESSA witnessed an average top-line growth of 2% and 11% from Q3 2017 to Q3 2018. The North America Beverages (NAB), on the other hand, fell by an average of 2% during this period.

A further deep-dive into the financial results reflects that the PepsiCo’s beverage segment (NAB) has been fizzling out for several years now and as is reflected in the below chart. The top line for beverage segment grew by ~15% (CAGR) from 2008 to 2011 and toppled down by ~1% (CAGR) from 2011 to 2017. In absolute terms, revenue has stagnated in the range of USD 63-67 billion in the last five years. Similarly, operating margins have also collapsed from their peak of 21% (2009) and have remained stagnant in the range of 12-14% in the last five years. 

The segment (NAB) has been losing particularly on its namesake; cola and all its variants. This declining trend started a few years back in 2012, which was driven by a dip in sales volume for both the carbonated soft drinks (CSDs) and the non-carbonated drinks such as juices and health drinks (Tropicana and Gatorade). Though non-carbonated drinks and health drinks did show a marginal improvement in some of the quarters. However, sales volume for CSDs has been consistently declining since 2012. This deteriorating trend continued in the first two quarters of 2018 as well. On a y-o-y basis, the revenue for NAB segment declined by 1% in Q1 and Q2 2018 and operating profit dipped by 23% and 16% in Q1 and Q2 2018, respectively.

This decline was triggered by the changing consumer preference, a shift from carbonated and sugary drinks to healthier options over the last few years. According to the Beverage-Digest, a trade publication, the consumption of carbonated soft drinks fell to a 32-year low in the U.S. in 2017. Moreover, there had been some marketing slip ups by the company where its core brands were neglected over some new introductions. These missteps resulted in the replacement of the shelf space for core brands with smaller and next generation brands in grocery and convenience stores. This was acknowledged and highlighted by the PepsiCo CEO, Indra Nooyi during the Q2 2017 earnings call. She stated, ‘this summer, we directed too much of our media spending and shelf space to low-calorie, much smaller brands at the expense of our Pepsi and Mountain Dew trademarks.’

Hence, the management is aware of changing consumer preferences and understands the urgency to fix the slumping North American Beverage segment. Furthermore, during the Q2 2018 earnings conference call, Nooyi stated that ‘we're maniacally focused on getting this business back on track.’ Further, the company has already taken several steps to cater to the changing consumer preferences as well as corrective actions on the marketing front. These include an introduction of new products, healthy variants of its existing brands as well as increased marketing spend on its core brands together with new launches. The new entrants in its beverage portfolio include sparkling water brand ‘Bubbly’, new flavours in its ready to drink tea, low-calorie versions of its trademark Pepsi among others. It also partnered with Starbucks in the ready-to-drink coffee business to benefit from their strong innovation pipeline. In August 2018, the company entered into an agreement with SodaStream; an Israeli company that offers machines and refillable cylinders to make carbonated drinks at home. This is expected to be popular with the consumers as it additionally takes care of the environment by getting rid of plastic bottles and cans.

In order to match to its primary competitor Coca-Cola, PepsiCo expanded its advertising and marketing spend on NAB products by ~6% in the last one year.

The company has been taking these steps for the last 6 to 8 quarters and their efforts seem to be paying off (though gradually) as reflected in the latest results, Q3 2018. The company’s NAB segment delivered 2.5% growth to its revenue, however, the profitability was impacted by an increase in the advertising and marketing spend during the period. The top line growth was the result of the surge in both the price as well as the volume. The increase in retail sales volume was, in turn, driven by growth in ready-to-drink products from Starbucks, Lipton, Gatorade, Pepsi, Mountain Dew and PepsiCo’s water brands such as bubbly and LIFEWTR.

Although the snacks business has been performing exceptionally well and offsetting the lacklustre performance of the beverages segment, a consistent decline in the beverage segment in the last few years has been a cause of concern for the management as well as for investors. However, the corrective steps taken by the management in the last couple of years have started to show some signs of relief as the beverage segment posted a 2.5% growth in Q3 2018 after declining for five continuous quarters. Nonetheless, PepsiCo’s efforts on advertising and marketing, an introduction of healthier options and other cost-saving initiatives are expected to be even more aggressive in the coming years, particularly for North America Beverage segment and a turnaround of this segment’s fortunes.