As the world economy slows down, few companies in the traditional food and beverage industry managed to grow their business. PepsiCo, Inc. (NYSE:PEP) is an exception. The company generated solid growth in the most recent quarter. Organic revenue grew 5.1%, while core constant currency EPS surged 11%. PepsiCo’s stock price crossed above the $100.00 mark earlier this month.
Today, the company’s shares trade at $99.23 apiece, up more than 50% over the past five years. But due to its durable competitive advantage, I think this stock has even more upside potential. (Source: PepsiCo, last accessed August 14, 2015.)
Wide Economic Moat
Pepsico has a very wide economic moat. “Economic moat” is a term coined by billionaire investor Warren Buffett. It refers to a company’s competitive advantage wherein it protects itself from the competition. When it comes to competitive advantage, Pepsico is in a good position.
PepsiCo’s brand recognition is one of the best in the whole world. Its international recognition means many consumers will not switch to cheaper brands. Moreover, it has built a solid distribution network, and has relationships with retailers that new entrants in the industry could only dream of.
A wide economic moat allows the company to profit in the ever-competitive food and beverage business. In the second quarter of 2015, PepsiCo’s core gross margin expanded 115 basis points, while core operating margin increased 60 basis points.
Based on its solid performance in the first half of the year, along with a positive outlook for the remainder of this year, Pepsi raised its guidance. The company expects its core constant currency EPS to grow by eight percent in 2015 (previously the guidance was seven percent).
Foreign exchange is expected to continue causing headwinds to the company’s financials: the unfavorable impact is estimated to be nine percentage points on full-year net revenue growth and 11 percentage points on full year core EPS performance.
Despite having a wide economic moat, PepsiCo is not standing still. In fact, the company started increasing its R&D investment since 2008. From 2011 to 2014, PepsiCo’s investment in R&D increased by nearly 40%.
Over the past several years, the company introduced a number of products that have achieved, or are on their way to achieving more than $100 million each in annual retail sales. These include “Tostitos Cantina,” “Mountain Dew Kickstart,” “Doritos Cheetos Fun Multipack Mix,” and “Gatorade Fierce Blue Cherry” and “Frost Glacier Cherry.”
PepsiCo’s innovation efforts have paid off. In 2014, innovation as a percentage of total revenue reached nine percent—a 150 basis point increase compared to two years ago. The company’s innovation has also been recognized by the industry. In 2015, three PepsiCo products received the Nielsen Breakthrough Innovation Award.
The company’s innovation strategy also takes consumers’ health and wellness demand into account. As more consumers started to enjoy plant-based proteins like almond milk, PepsiCo’s “Naked Juice” launched two new nut milks, “Berry Almond Nut Milk” and “Peachy Almond Nut Milk.”
The company is also very adaptive when there are controversies surrounding its products. For example; previously, the diet soda industry always used aspartame as the sweetener. However, despite being found safe by the U.S. Food and Drug Administration, aspartame has been the subject of several controversies. What did PepsiCo do? It got rid off the controversial sweetener and started shipping reformulated diet drinks that are aspartame free.
PepsiCo now sweetens Diet Pepsi with less controversial sweeteners—sucralose and acesulfame potassium. The company also knows how to get the message out: the new Diet Pepsi cans say “Now Aspartame Free” on the front.
On Friday afternoon, Pepsi shares were trading at $99.15 apiece. Its price-to-earnings ratio (P/E) is at 22.86, lower than its rival The Coca-Cola Company’s (NYSE:KO) P/E of 24.06, and much lower compared to the industry’s P/E of 33.11. With a lower P/E and a better outlook, Pepsi stands out among its peers in a good way.
Moreover, Pepsi has been a long-time income investor favorite. The company has increased its dividends for 43 years in a row. This means it managed to create value for shareholders during several market downturns. In today’s world economy, where China is slowing down and Europe is still highly uncertain, consistent growth in PepsiCo makes the company a lot more attractive in the eyes of income investors. I wouldn’t be surprised if the upward trend in PepsiCo’s stock price continues on.