The longer I invest, the more I realize how much different true value investing is from what the rest of the market is doing. One of the key tenants of value investing is the margin of safety, which involves comparing the market price of a business and its intrinsic value – which means that an individual must be able to conservatively measure a company’s true worth in order to classify what they are doing as “investing.” The other thing that I find clearer with each and every passing day is how few people actually attempt to do this; from what I can tell, many people fail to bother reading 10-Ks (or don’t know what they are reading if they try to) – this is the only plausible explanation for why discussions about Staples (SPLS) rarely include mention of the delivery business, or why J.C. Penney’s (JCP) success or failure has been proclaimed based upon six months of operations that have nothing to do with the strategy that management has outlined for investors.
Another example where I think this is true, albeit to less of an extent, is with PepsiCo’s (PEP) snack business; while it would be disingenuous to say that the financial community never discusses it, I think it’s accurate to say that they never give it the time that it’s worth. Considering that Brian Cornell, the CEO of PepsiCo Americas Foods, recently updated investors and analysts on the state of the business, I thought there was no time like the present to bring readers up to speed on the strength of PepsiCo.
PepsiCo is the second largest food and beverage company in the world (behind Nestle (NSRGY)), and the largest in North America. In 2011, PepsiCo America Foods (PAF) reported $23 billion in sales, and $5.5 billion in operating profit (24% operating margin). Of that total, Frito-Lay North America accounted for 58% of the revenue ($13.35 billion in sales), and 65% of the operating profit ($3.58 billion), for an FLNA operating margin just shy of 27%.
In addition to being a huge market, PepsiCo continues to grow: Over the past three years, revenue and operating profit for PAF have increased at a rate of 5% and 7% per annum, respectively. This growth is on the back of industry-wide salty snack growth, with dollars up 2% in 2010, 5% in 2011, and 6% through the first six months of 2012.
PAF has a go-to-market system that services more than 2 million customers across 50,000 routes; this level of penetration partly explains why this segment is home to seven of the company’s 22 $1 billion brands (they are Lay’s, Doritos, Tostitos, Cheetos, Ruffles, Fritos and Quaker). In addition, the company is the No. 1 supplier to the C&G channel and the No. 1 contributor to C&G growth according to IRI data; this means that when PepsiCo asks for product placement or additional shelf space, retailers have a vested interest in making sure that they do all they can to make it happen.
Among the price tiers for salty snacks (value, mainstream and premium), Frito-Lay holds a dominant position across all three:
|Price Tier||% of Retail Sales||Frito-Lay Share||Market Position|
Despite this dominance in the mainstream market, FLNA is not resting on its laurels – year to date, the company has increased media spend on mainstream brands by 30% to increase brand equity – which according to early research has had a material impact on top of mind awareness among targeted consumers; in addition, they have pumped money into innovating across the entire portfolio, with solid innovations in all three of the key price tiers.
While 7% of retail sales for the Premium price tier might not sound like much, remember that this category is growing (Premium dollar sales growth was +4% in 2010, +10% in 2011, and +18% through the first half of 2012) due to increased penetration among baby boomers (health conscious) – and that even at this point, this category represents a $2 billion opportunity to PEP.
The share data from above shows just how dominant this business really is – and the consistency of results from year to year confirms the strength of the moat around the business that insulates FLNA from the effect of competition (of which there is plenty); if one looks around the world, they would find similar results – with PepsiCo commanding roughly 25% of the $63 billion (at retail) global savory snack market from just its seven billion dollar brands. This is much different than the Coca-Cola (KO) story: You don’t hear about this domination very often – which is a blessing for value investors willing to dig and find gems buried in 10-Ks and conference call transcripts.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.