PepsiCo Hints at No Acquisitions

During  PepsiCo's (PEP) fourth-quarter earnings call, management said it plans to retain the North American bottling operations, remains committed to the Power of One initiative, is looking at entering the at-home market, and is increasing its annual dividend 15% to $2.62 per share. We continue to believe Pepsi's wide moat is bolstered by its vast distribution system and exceptionally strong brands. While management's forecast of $4.50 in core earnings per share for 2014 is moderately lower than our estimate of $4.77 (primarily due to currency), Pepsi still believes longer-term core constant currency earnings per share can grow in the high single digits, and so do we. Consequently, we do not anticipate making a material change to our fair value estimate.

During the past year, Pepsi has retained an army of consultants and investment bankers to look into the optimal course of action for its North American bottling operations. After much deliberation, Pepsi has decided to maintain the current structure. Management said the existing structure provides operational and customer scale benefits, is well positioned in the noncarbonated and flavored carbonated soft-drink categories, and should continue to benefit from various productivity and innovation initiatives. We believe some of these innovations will include naturally sweetened (Stevia-based) sodas that will be test marketed in the United States.

Following  Coca-Cola's (KO) recently announced partnership with Green Mountain Coffee Roasters to enter the at-home market, it isn't surprising that numerous questions popped up during the earnings call about Pepsi's intentions to enter the at-home market. While the responses were somewhat coy, it was clear that Pepsi is assessing multiple single-serve systems. Additionally, management again vehemently denied the need to make any acquisitions, which we take to mean it is currently off the table for Pepsi to acquire  Monster Beverage (MNST) or SodaStream International .

During 2014, PepsiCo plans on returning $8.7 billion of cash to shareholders. Its increased dividend will account for $3.7 billion of this amount, representing a 3.2% dividend yield, and share repurchases will represent $5 billion. We note that the cash return to shareholders and anticipated capital expenditures (less than 5% of sales) will exceed cash from operations, so we expect leverage will slightly increase. However, management remains committed to maintaining a Tier 1 commercial paper program, so we do not anticipate any deterioration to the firm's investment-grade bond rating.

CEO Indra Nooyi remains committed to the Power of One and keeping the beverage and snack businesses under one roof. She notes that the company achieves $800 million-$1 billion in annual synergies--including shared procurement and customer insight organizations and joint advertising with the NFL and MLB--and that when the two portfolios are combined, PepsiCo ranks as the top supplier to many large grocery store chains.

Management also announced its plan to drive $5 billion of productivity savings ($1 billion per year) from 2015 through 2019. These cost savings will come from four areas: automation, shared services, optimizing its manufacturing footprint, and optimizing its distribution network. Given that much of these savings will stem from the company's North American operations, we think it makes sense for PepsiCo to hold on to its bottlers while it continues to streamline and improve operations.

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