Why Frito-Lay Is the Most Valuable Segment For PepsiCo

We estimate that almost 40% of  PepsiCo‘s (NYSE:PEP). valuation comes from Frito Lay-North America.  This division currently commands around 36% of the growing North American savory snacks market. We expect this market share to remain steady over our forecast period.  Pepsico’s dominance in this business is critical to its long-term growth, as a moderate increase in Frito-Lay’s market share can compensate for a significant decline in the market share of any beverage division.  This is primarily because Frito-Lay’s EBITDA margins are almost double those of the beverage divisions.

Each Basis Point Increase in Frito Lay’s Market Share Can Compensate For a 1.5 Basis Point Loss in PepsiCo’s Market Share

Using Trefis Interactive technology, we create a scenario where we assume a 20% increase in Frito-Lay’s market share from the current 36% to around 44%  at the end of  forecast period. (An increase of 800 basis points).  This results in around 10% upside to our price estimate.

Keeping the above estimate intact, we now reduce the market share of PepsiCo soft drinks to arrive at our original price estimate.

To do this, we need to reduce PepsiCo’s Global CSD market share, from the current 20% to a low of 8%, a reduction of 1,200 basis points. Thus, a 20% increase in Frito Lays’ market share can compensate for a 60% decline in PepsiCo’s soft drinks market share to keep the valuation intact.

Higher Margins, Better Prospects For Frito Lay

The snacks business is more than twice as profitable as the beverage business for PepsiCo.  For each $100 earned, Frito-Lay generates $35 towards EBITDA, while PepsiCo soft drinks generate only $16.  An increase in revenues of Frito Lay’s business would have a significant impact on its valuation.

This works tremendously in PepsiCo’s favor.  Its profitable snacks business, of which Frito Lay is a major component, is growing. (Read Pepsi’s snacks more crucial to overall growth)  We expect this market to grow at a CAGR of 2% by value through 2014-2019.

The global CSD market, on the other hand, is expected to grow only at 0.5% in the next few years, and this growth is likely to come primarily from emerging markets. There are growing concerns around obesity and diabetes, which may stall growth in this market. From a valuation perspective, Pepsi can compensate for a 150 basis points decline in its CSD market share, with a 100 basis points increase in its Frito Lay’s market share.

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research