Now that we have indulged our thirst for numbers and quantification of PepsiCo in part 1 and part 2 of this valuation, what are we to make of its value to its customers, suppliers, admirers and detractors? What is the philosophy of this business, and is it stable or fleeting, and how will it evolve in the future?
In the 1990s I once wrote, only half-jokingly, that the four food groups of actual importance were fat, sugar, salt, and chocolate. While anyone with a need for their day's calories can take or leave a bowl of wet barley, they are more likely to look fondly of, and pay more for, food that delivers more potent kicks to their pleasure centers. Of these, PepsiCo delivers only fat, salt, and sugar, with perhaps some traces of chocolate among their Grandma's Cookies, chocolate chip variety.
If you look at each line of business, they do sort out somewhat by this key factor: snack chips made by the superior business Frito-Lay contain both fat and salt (two factors), but Pepsi contains only sugar (one). Of course, Quaker Oaks contains none of the special factors, and since its operating margins are better than those of soda pop, it wrecks my thesis. Worse, we've ignored the fact that among all substances, water is actually more vital than any of fat, sugar, salt or chocolate, and so possibly might command the highest attention. So, while this idea might be at least somewhat clever, it is too simplistic to take seriously.
Nevertheless, we have a handle on what makes PEP a possibly worthwhile and stable business. Carbohydrates in an appealing form tend to attract notice: pasta, pizza, bread, doughnuts, bagels and so on. If it is flavorful and has an interesting texture, people tend to be attracted to it, and they return for more periodically and with relish. Take corn and mix it with oil, bake it until it is crunchy, salt it, and you have the first word of the Frito-Lay company name.
If you are concerned about health and the quality of food, its vitamin and mineral content, then you are thinking as PepsiCo's recent CEO Indira Nooyi did. To fulfill the need for multi-grains PepsiCo has Sun Chips, for fiber and healthy grains there is Quaker Oats, for low-sugar beverages there is Gatorade, for low-fat foods there are the Baked versions of Frito-Lay's potato chips and corn puffs. While it is still not quite the same as eating raw kale plucked from the ground twelve minutes ago, people are actually willing to eat some of these. After all, you can't digest what you never ate in the first place.
Frito-Lay Investment Thesis
There is little need for me to describe the taste appeal of snack chips here. Potato chips, pretzels, corn chips, tortilla chips, popcorn, and other salty snacks have an enduring appeal. PEP has a leading position in all of these segments and some of the best brand names in the snack business. Though there is plenty of competition, PEP competes quite well on taste, package appeal, breadth of product offering, and quality. This is not a category that needs to be sold to people, they naturally seek it out.
In some snack categories Frito-Lay dominates, and is unlikely to be displaced by competitors. The original Fritos corn chips have no significant competition. In the tortilla chip segment, Doritos Nacho Cheese is a classic that may never be equaled by any snack chip.
Despite having a commanding lead, at least in the U.S., Frito-Lay experiments with flavors, packaging combinations, and new product categories. Examples include flavored peanuts, Munchies, an annual flavor competition where customers are invited to propose new potato chips flavors, and the hot and spicy flavor mixes (e.g. Flamin' Hot Limon).
Competitors include Pringles, owned by Kellogg's, Snyder's-Lance, Inc., now a division of Campbell Soup Company, and many, many startups offering products with features aimed to appeal to those seeking healthier or organic foods. Flavored popcorn, alternative root vegetable chips, and vegetable-based snacks are some examples of marketing to segments of the populace seeking to elevate themselves above others through their snack choices. These products are always higher in price, lack distinctive branding, and can often be found at the discount warehouses like Costco.
Frito-Lay has a number of regional competitors. There has been some consolidation over the last 20 years. Utz (NYSE-UTZ) is probably best known for its potato chips in the Atlantic states area (PA, MD, VA, et al). It makes excellent potato chips equal or superior in quality to Lay's. Warren Buffett is supposedly fond of their potato sticks. It acquired Zapp's (Gramercy, Louisiana) in 2011 and Golden Flake (Birmingham, Alabama) in 2016.
PepsiCo North America Investment Thesis
Over 25 years ago I commented on the appeal of PEP to a friend, who immediately said "but I like the taste of Coca-Cola." It's hard to argue with the idea that Coca-Cola is one of the best known brands in the world. People like Coke, they collect merchandise with the logo, and it is part of America's heritage. Does Pepsi have the same appeal? Hardly.
On the other hand, what of Mountain Dew? Over the years it has continued to grow in strength, shedding competitors of all types, including many that Coca-Cola itself has created to compete with it. Though not quite of the stature of Coca-Cola, Mountain Dew sits in a unique marketing position of name, taste, product color, and sense of serious exuberance unmatched by other soft drinks. Older readers may remember the original marketing, the natural outdoors and sense of a wholeness of the honest person uncontaminated by the excesses of ego. As one might expect, it is difficult to capture in mere words what feelings the brand evokes. Certainly, though, Mello Yello, Sun Drop, Surge, and similar competitors have failed to make much of a dent in Mountain Dew's market segment.
As for the appeal of the product category, that of sugary beverages, it's not a coincidence that the leading soda pop companies were started in Southern states before air conditioning became a widespread convenience. Those who have worked outdoors in high temperatures for an extended period know the appeal of a carbonated beverage.
Both Coca-Cola and PBNA have had trouble with shrinking sales the past decade. Some chalk this up to people making healthier choices, cutting back on sugary drinks, switching to natural juices, and so on. But I wonder, how much of the trend is due simply to people being less exposed to the outdoors? How many Americans stay inside all summer, in comfortable air conditioning or perhaps jumping between air conditioned spaces? The phrase "quenching a thirst" means less than ever to a growing segment of the population.
PepsiCo and Product Background
I'll close this part of the PepsiCo valuation series with some links to general information about PepsiCo. I'm not saving you much work here, as you can just Google or DuckDuckGo and find this kind of stuff yourself. But there are some shortcuts worth passing along, so here they are.
You may want an overview of what PepsiCo makes. Ironically, perhaps the best way to do this is to find a boycott site, where they try to identify everything that you want to avoid. There's a Foodbeast posting in 2017 that's like this. Doing an image search for "pepsico products list" is also productive. Or you could go to the official source.
Frito-Lay North America Fact Sheet is a two-page flyer with an overview and basic numbers about FLNA.
The FLNA employment site has some videos and provides a good overview of most phases of the business, from manufacturing to in-store merchandising.
The Flamin' Hot product line was introduced to Frito-Lay by Richard Montañez. For the fascinating story, look at tanksgoodnews. A movie is supposedly in the works.
More about Flamin' Hot Cheetos on Mashed.com.
Food and Beverage Resources
PotatoPro offers very broad potato industry connections for growers, processors, retailers, restaurants, equipment makers, agricultural supplies and makers of derived products. Frito-Lay is, of course, just one of many companies listed on the web site. I found a deep reservoir of past press releases that are searchable, making it quick to chase down brand names or trace acquisition histories.
Soft drink market share according to Statista.
History of soda pop by Mary Bellis at ThoughtCo.
Mystery Products and Competitors
It was not a Frito-Lay product, but perhaps one of the best Flamin' Hot competitors could be Harvest Hot Crunch. It was sold briefly at Dollar Tree about eight to ten years ago. I sampled these myself, and as I recall they were better than Flamin' Hot Cheetos, and this food reviewer seems to have agreed, giving it a 10/10 score. I have never seen it since, but if it were resurrected it would be significant competition.
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