PepsiCo Is Trying to Change With the Times

Once primarily a sugary-beverage company, PepsiCo (NASDAQ: PEP) has been on a journey to transform itself into a snack food and beverage powerhouse with a focus on healthier options.

This pivot has been dictated by changing consumer tastes. Over the years PepsiCo has branched out into non-carbonated beverages, snacks, dips and healthy juices in response to younger consumers moving away from sugary sodas and artificial ingredients. Now, about half of PepsiCo’s beverage volume is generated from low or zero-calorie drinks. The consumer giant now breaks down its portfolio into three main product categories: “fun for you,” “better for you,” and “good for you,” with healthier products making up almost half of its portfolio today.

As the industry shifts toward cleaner label and healthier options, PepsicCo continues to evolve its portfolio of brands, albeit at a much slower pace than many shareholders would like, in an effort to find growth and avoid stagnation.

Another new PepsiCo brand: Bubly flavored sparkling water. Source: Pepsico

Who is driving the change?

According to Food Navigator and market research firm IRI data, millennial consumers are a major force in much of the change to so-called “clean label” products with natural ingredients. They are more demanding in terms of ingredients and the experience that a brand can provide. And millennials show strength in numbers, accounting for 25% of the population in the U.S. and around one-third of all spending on consumer packaged goods.

To keep up with the changes in the industry driven by the shifting consumer demands, PepsiCo is using a number of strategies including flavor and product innovation which has involved intensive R&D spending, amounting to $737 million in 2017. The company has also started scooping up fast-growing niche brands like KeVita range of probiotic beverages, which PepsiCo acquired in 2016.

PepsiCo’s most recent product launch Bubbly, which has no artificial flavors or sweeteners, and the announced acquisition of Bare Snacks, a producer of non-GMO, preservative-free snacks, both show the company is trying to find ways to provide millennial consumers with clean label options.

PepsiCo’s current performance

For the first quarter of 2018, the company reported sales of $12.6 billion with organic revenue growth of 2.3%. The volume was driven primarily by its snack food business with overall growth of 3%, compared to beverages, which reported a 1% decline.

And while, the company’s healthy brands like Lipton and Pure leaf tea continue to perform well, PepsiCo also faces serious challenges, particularly in its North American Beverage group where the sharp decline of cola sales (which accounted for 12% of sales in 2016) and increasing cost pressures across the entire business are making a dent in the performance.

This year, PepsiCo shares have been underperforming in part due to its inability to stem the bleeding of its North American Beverage group. Its core products under the Pepsi trademark have lost significant share, while niche brands like KeVita — which grew 50% in retail sales in Q1 — are still not big enough to help PepsiCo return to growth. To address this, the company has stepped up its media spending to prop up its cola products, but warns that the effects of the increased investment might take several quarters to show up.

Where to from here?

PepsiCo expects to achieve organic growth of at least 2.3% in 2018 compared to last year. And while it has been reformulating existing products to reduce sugar and sodium and launching more-nutritious choices across its entire product portfolio, the challenge remains in getting the product mix right. Many of its fast-growing brands are still too small to balance out the declines and volatility that the company is experiencing.

Getting to the sweet spot may take a number of years, so investors expecting a turnaround should be ready to wait.

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Aksana Fitzpatrick has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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