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Stock Strategist

Still Some Pop Left in Pepsi

A leading portfolio of beverages and snacks will feed returns on invested capital.

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 PepsiCo’s (PEP) leading portfolio of beverage and snack brands has carved out a wide economic moat for the company, ensuring excess returns on invested capital over the long run. We believe Pepsi and Coca-Cola (KO) will continue dominating the domestic nonalcoholic beverage market, with their entrenched retail relationships and economies of scale creating powerful barriers to entry. Moreover, we expect rational pricing relationships between the companies to persist over the long run, leading to gains from price and product mix. Although Coca-Cola’s carbonated soft drinks enjoy greater share abroad, we believe Pepsi’s snack portfolio is well positioned for international gains. Pepsi also has established agreements to distribute brands such as Starbucks, Sabra, and Rockstar Energy, further strengthening its retailer relationships.

We anticipate growth will be fueled by Pepsi’s noncarbonated beverage and snack businesses, which should enable the company to offset the impact of secular declines in the consumption of carbonated soft drinks (which account for less than one fourth of overall sales) in developed markets. We appreciate the company’s focus on “guilt-free” products (roughly half of sales) that align with consumer trends, and we think sustained brand-related investments, with combined expenditures on advertising and research and development remaining above 7% of sales over our forecast, will allow Pepsi to develop and market innovative new products, bolstering the intangible asset source of its wide moat. In addition, efforts to drive efficiency gains, targeting $1 billion in savings annually, stand to enhance its margins and free up funds to support its product set.

Sonia Vora does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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