The Business Of

Fast Food | PepsiCo | How Do They Make Money?

Morning All!

So yesterday, we started the third and final part of The Business Of Fast Food. Our focus this week is on PepsiCo - the 34th largest company in the world. And we saw yesterday that PepsiCo doesn’t mean Pepsi! The company own >20 brands that each make >$1 billion in retail sales. Unfortunately, the company don’t split out how much each brand makes. But here’s a reminder of some of the famous brands…

Now, instead of saving the overall revenue chart for the end of the newsletter. I’m going to show it now because it makes for pretty odd reading. As we can see below, from 2012-2020, PepsiCo had super low revenue growth! With growth less than 5% in each of those 9 years. But then more recently, we can see that revenues picked up again in 2021 and 2022.

So, what’s happened here? Well, first we’ll tackle what happened in 2012-2020 and the super slow growth. And then we’ll come onto what’s been happening recently with the stronger figures. Sound good? Good - let’s get cracking!

Currency Spoiling The Party…

Okay, so the first part of today’s newsletter will actually go through something we haven’t yet talked about in The Business Of. And that’s currency fluctuations. Maybe not the most exciting topic - but definitely an important one to understand! So, what do I mean by currency fluctuations?

Well, PepsiCo is a global business. The chart below shows us that whilst North America makes up a majority of sales (61%). The company really makes money all over the world… as we’d expect. Pepsi, Doritos, etc are everywhere!

And whilst it’s great that people all over the world love PepsiCo’s brands. It does bring a slight complication. And that complication is currency risk, or FX risk. To illustrate this, let’s go back to 2014 and use an example.

Now, let’s say that in 2014, PepsiCo sold £100m worth of Pepsi to Tesco. And in 2015, PepsiCo increased the price of their Pepsi and also sold a bit more. And hence sold £105m of Pepsi to Tesco. So, 5% constant currency growth. And we can see this in the first row of the table below.

However, this is where FX risk comes into play. Because PepsiCo don’t report their financial statements in pounds. They report in dollars. So, what do we need? The exchange rates!

The average exchange rate between the US dollar and the UK pound in 2014 was £1 = $1.65. And the average exchange rate in 2015 was £1 = $1.53. So, that £100m of sales in 2014 would be reported as $165m (100 x 1.65). And the £105m in 2015 would be reported as $161m (105 x 1.53). And as we can see from the table above, the 5% growth IN POUNDS, becomes a -3% decline IN DOLLARS!

Now, some of you may be a bit perplexed by this. How does 5% growth become -3%?! Well, it’s because of the movement in the exchange rate. £1 was worth 7% less in 2015 ($1.53) than it was in 2014 ($1.65). And so any revenues PepsiCo made in the UK will be affected!

Okay, but why am I going through this? Well, because this is exactly what was affecting PepsiCo’s growth from 2012-2018. The chart below shows us that whilst organic growth (blue line) was fairly decent over this period. It was the negative exchange rate movements that dragged down overall growth.

But you may be wondering - what exchange rate movements happened in 2015? Well, the US dollar strengthened a huge amount. For those interested, the reasons are in this article here. But this strengthening had a negative impact, not only on PepsiCo. But on all companies that report their financial statements in dollars but make revenues in several currencies.

Is Anyone Really Drinking More Pepsi This Year?

Okay, so hopefully that’s clear! FX impacts played a big role in PepsiCo’s slow revenue growth from 2012-2018. But hold on a second. Surely we can’t blame currency movements for all of the slow growth! Because in that previous chart, we can see that even the organic growth isn’t that great! So, let’s turn our attention to organic growth.

As always, we’ll break it down into volume growth and pricing growth. And interestingly, the chart below shows that over the last decade, there’s hardly been any volume growth at PepsiCo! Now, what’s going on here?

Well, when you think about it. What does volume growth really mean? It means that Tesco, Walmart, Nando’s, McDonald’s, etc. will be buying more Pepsi every year. But why do they need to buy more Pepsi than they did the year before?! It’s not like people are suddenly going to drink loads more Pepsi in 2023 than they did in 2022! Of course, some people might start drinking loads more Pepsi this year vs last year. But on average, people will drink about the same amount.

But then what about new regions? Last week, we saw Huel grow revenues by going to new regions. Can’t PepsiCo do the same with Pepsi? Well, not anymore! Because Pepsi is already in every country! And this is something we noted in The Business Of Netflix. As a company becomes global, it’s hard to find new people to purchase the product. How many people haven’t already heard of Netflix globally? Very few. How many people haven’t already heard of Pepsi? Even less!

No One Pushes Walmart Around

Okay, so we’ve seen that it’s difficult to grow through volumes when you become the size of PepsiCo. But what about pricing? In the earlier chart we saw that pricing growth went seriously high in 2021 and 2022. But like volume growth, it seems pretty low for the prior decade.

But surely if PepsiCo wanted to lift their prices by a lot - let’s say 10% every year - they could right? I mean they’re PepsiCo! They’re huge. Well, what we’re about to see is no - PepsiCo can’t do that. Because despite their size, PepsiCo aren’t the ones in control…

Hmm okay, but then who is in charge? Well, remember when we looked at The Business Of Tesco. We saw that Tesco removed Heinz products from their shelves because Heinz wouldn’t agree to the price Tesco wanted. Well, it’s the same dynamic here. When it comes to negotiations with their biggest customers, PepsiCo don’t have the final say.

Why? Well, let’s take PepsiCo’s biggest customer. In 2022, the US giant, Walmart made up 14% of PepsiCo’s revenues. And by the way, when I call Walmart a giant. I really mean it. There is no company in the world that makes more revenue than Walmart! not Amazon. Not Apple. No one. You can see the top 10 table below for proof!

What that means is that Walmart is more important to PepsiCo than PepsiCo is to Walmart. What do I mean? Well, the chart below shows that PepsiCo made $86bn in revenue in 2022. And $12bn of that was from Walmart. That’s 14%.

But now let’s look at Walmart. They would have marked up that $12bn worth of drinks/food they bought from PepsiCo. So, let’s say they sold $16bn of PepsiCo products in 2022. Whilst $16bn is a lot of money… that’s only 3% of Walmart’s total revenues!

So, let’s say PepsiCo want to raise prices to Walmart. And Walmart don’t agree. If PepsiCo say ‘Right, we’re off - no more Pepsi, Lay’s Doritos, etc at Walmart’… who’s that going to affect more? PepsiCo! They’ll be losing 14% of their revenues. Whilst Walmart will lose only 3%! And it’ll be a similar story in the UK. With Tesco more important to PepsiCo than PepsiCo is to Tesco.

So, I hope that’s clear. Whilst PepsiCo are huge. They don’t have pricing power with their customers. And this does limit their growth. However, as we said earlier, pricing did increase massively in 2021 and especially 2022. And most of us will be feeling the effects of this - supermarket prices are so much higher now! And tomorrow we’ll look at PepsiCo’s role in this!

Walmart Might Be First, But Bottling Partners Aren’t Far Behind…

So, one short, final thing I want to end on is the point at which PepsiCo make their money. What we’ve talked about today has mainly been PepsiCo selling their finished goods (ready for sale) to Walmart and Tesco. But we saw yesterday that PepsiCo also sell their ‘secret syrups’ to partners who then bottle/package their products. And it’s the bottling partners’ job for getting the Pepsi to Tesco.

Sadly, PepsiCo don’t give us the split between how much of their revenues are from selling syrup to bottling partners. Versus selling finished goods to retailers. But fortunately, their number one competitor does split it out for us!

In Coca-Cola’s 2022 annual report, the company shows that 44% of their revenue comes from selling finished goods to retailers like Tesco and Walmart. But the other 56% of revenue comes from just selling their syrup to bottling partners! This takes a bit of time to understand, so let’s save it for tomorrow!

13th Jun 2023

Nigel Jacob CFA