- Background and Industry

Pepsi is a leading food and beverage company with operations in 220 countries around the world. It was first established in 1956 by Don Kendall and Herma Lay. Since then, the company has grown into globally recognized brand generating over $67 Billion in revenue. The most notable brands from the firm are its Pepsi Cola, Gatorade, Doritos and Lays brands. It also distributes many poplar beverages such as Tropicana, Aquafina, and Brisk. The overall industry is very saturated and competitive. Healthy drink options are now becoming a much more prominent choice for consumers. As a result, organic growth for the company has been roughly in line with overall GDP growth. The companys primarily competitors are Coca-Cola, Dr. Pepper Snapple, and Red Bull within the beverage market. Its primary competitors in the snack market are Mondelez, General Mills, and Proctor and Gamble. Each competitor has very strong market share, financial resources and business acumen. As Pepsi has a very strong brand, it doesnt necessarily compete solely based on price. It instead invests heavily in the brand to help it stave off competition.

2- The Financial Leverage Ratios

Year

2019

2018

2017

Debt to Asset

0.41

0.42

0.49

Debt to Equity

2.17

2.23

3.61

Interest Coverage

9.2

7.03

9.34

(Source: https://www.stock-analysis-on.net/NASDAQ/Company/PepsiCo-Inc/Ratios/Long-term-Debt-and-Solvency#Interest-Coverage)

To begin leverage and solvency ratios are critical to determining the long-term viability of the Pepsi franchise. As the company is very consistent, with stable operations the company support a much higher debt burden than many cyclical companies. Also, the company generates substantial free cash flow in which to service the debt over long periods time. In the currently low interest rate environment, Pepsi is also in an advantageous position to issues bonds are very favorable rates to finance operations with very high returns. Due to these elements, the overall financial leverage of Pepsi is favorable.

The firm finances roughly 60% of its assets through equity with the remainder being financed with debt. Roughly 40% of its $78Billion of assets are comprised of property, plant and equipment and goodwill. In March 2020, the company issued roughly $1.5B of international bonds maturing in 2025 paying 2.25%. The company through a press release intends to use the bond for general and administrative purposes, to build an R&D facility in Valhalla, New York, and to transition its delivery fleet into lower-carbon models. These bonds on an inflation adjusted basis are yielding less than 1%. This low yield indicates that investors believe that payment coupons and principle at maturity are highly likely. It also indicates that investors consider Pepsi as a very safe investment over the next 5 years. There appears to be very little risk with the issuance of the bonds primarily due to the economic reasons mentioned above. For one, the company has a very strong and entrenched market position. Its global operations provide revenue and profit diversification that is difficult for its competitors to match. It also has strong brands that generate stable cash flows through any market cycle. As a result, investors are willing to accept a much lower yield as they perceive the risk of default to be minimal. Risk is typically measure through duration and convexity. Here, duration risk measures a bonds sensitivity to interest rates changes. As the latest issuance is fix years, the duration is relatively short. However, a steep increase in interest rates will cause the bond price to decline. Likewise, a further lowering of interest rates will cause the bond to appreciate in value. Another risk associated with the Pepsi bonds is that of a permanent capital lose as a result of default. In this instance, the investor must make a judgement as to the likelihood of a severe deterioration of the...

…Return on Equity has been between 25% and 37% over the past decade. Revenue and profit growth although very tepid have also increased in a very methodical manner. Despite the qualitative and quantitative merits of the business, the stock fell 40% in march with little to no change in its operations as it relates to performance. This remind of a quote from Benjamin Graham, the father of value investing who said, In the short term the market is voting machine, in the long term the market is a weighing machine. From this assignment, I have realized that there is a lag between the voters of the market realizing the actual weight and merit of their investments.

Another concept that I have learned from the assignment is the short term orientation of traders when faced with uncertainty. As a younger individual, I understand that my future is uncertain. The idea is not necessarily to run from it but to face it. The markets however, tend to look only in the short term and sales whenever faced with uncertainty. Once the news of COVID-19 became apparent trades quickly sold very high quality companies at a fraction of their cost. A patient and astute investor could have purchased these companies at a fraction of what they were worth. Likewise, near Q3, the prevalence of day traders and retail investors took hold. Here, retail investors were bidding up the shares of companies from Tesla, Zoom and even bankrupt Hertz. In this instance greed and over optimism took hold and investors purchased companies that did not merit investment based on their financial performance. Tesla for example, as of this writing is worth $550Billion with sales only a fraction of that established auto market.

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