Back to Basics
Written by Paul Siluch
October 18th, 2023
Coca-Cola originally contained cocaine. It wasn’t put in the drink intentionally. It came as part of the coca leaf which, coupled with the kola nut for its caffeine, made up the special kick – cocaine and caffeine – of the original 1886 Coca-Cola beverage. The narcotic was removed in 1903 and the recipe revised, but the secret flavour was still good enough to make Coca-Cola one of the leading brands in the world a hundred years later.
Coca-Cola isn’t the topic of this week’s letter, but rather Pepsi-Cola. The number two soda pop producer deserves some attention because it has suffered this year.
Pepsi is not so sexy right now.
This makes PepsiCo, as it is now known, appealing to us at today’s levels.
Invented in 1893, Pepsi-Cola was brewed with kola, vanilla, citrus, and more sugar to make it slightly different than Coke. Well, that and no cocaine. Pepsi’s extra sweetness made a difference almost a hundred years later when Pepsi routinely beat Coke in blind taste tests, but we’ll get to that in a minute.
After stumbling through bankruptcy in 1923, Pepsi embraced its distant position behind Coke by offering twice as much for the same price: 12 ounces for the same price as 6 ounces of Coca-Cola. Sales promptly soared through the budget-conscious 1930s, making Pepsi-Cola the solid #2 soda brand. A feisty RC Cola popped up in the 1950s with its own version of the kola nut flavour and grew rapidly, but it faltered as the two giants out-marketed the #3 brewer. You can still find it today, but it is a very minor brand.
Pepsi used catchy jingles and movie stars to promote its brand.
1939: “Pepsi-Cola hits the spot, twelve full ounces that’s a lot.”
1969: “You've Got a Lot to Live, and Pepsi's Got a Lot to Give,“ ushered in the Pepsi generation.1984: Michael Jackson was recruited to sing about “The New Pepsi Generation.”
By the 1980s, Pepsi was outselling Coke in supermarkets. A clever marketing scheme called The Pepsi Challenge taste test pitted Pepsi against Coke in blind taste tests and Pepsi won most of the time because of its sweeter ‘first sip’ effect.
Despite this, Coca-Cola maintained its double market share of Pepsi, proving that marketing and global reach can overcome a little extra sugar.
The two companies began diverging in 1965. Pepsi-Cola merged with Frito Lay (pop and chips were a natural fit) which sent them on a far more diversified path than Coca-Cola. Too diversified, perhaps. Pepsi ended up owning the Pizza Hut, Taco Bell, and Kentucky Fried Chicken chains, which it decided to spin off in 1997. Yum! Brands, the successor company, has done quite well worldwide and still sells Pepsi sodas exclusively today. No Coke for you.
After the spin-off, Pepsi returned to its 1965 roots and refocused on drinks and snacks. The company bought Tropicana juices from Seagram’s in 1998 and Quaker Oats in 2001, which included the Gatorade line of sports drinks. Its Aquafina water competes with Coca-Cola’s Dasani brand and it recently bought SodaStream, the home carbonation company. Pepsi now partners with Starbucks and Lipton to market their coffee and iced tea drinks worldwide.
In short, they are everywhere.
Fun fact: Pepsi is known as Pecsi in Mexico because many Spanish-speaking people can’t pronounce the name Pepsi.
Even though PepsiCo has half the market share in carbonated beverages as its lifetime rival Coca-Cola (drinks now make up just 47% of its sales), the two companies are almost exactly the same size due to Pepsi’s huge food and snack arm.
Personal Pepsi Journey
When my son was born in 1995, I wanted to educate him in share ownership, which is something we believe wholeheartedly in.
But how would I do this? A mutual fund or market index is pretty boring to a five-year-old. And his favourite toy – Lego – is a private company.
I looked for a company with staying power and a dividend so I could “show him the money” frequently.
So, I chose shares in PepsiCo. Every quarter, we talked about the dividend that was just paid. The highlight was the annual report with its colourful catalogue of foods, drinks, and brands he knew. Or came to know. He became a fierce proponent of Aquafina over Dasani water with his soccer friends.
We had one rule: we could never sell. We would be the Warren Buffett’s of Pepsi: long-time holders that take advantage of price drops to add more. And we did. Whenever Pepsi struggled, we knew this 140-year-old company would get back on its feet.
Pepsi’s (Still) Got a Lot to Give
Which brings me to the present day. Pepsi shares have fallen 11% from their January opening price and are -17% since the high in May. That’s almost $50 billion lost in market value, which is a lot of chips, even for Pepsi.
What’s wrong?
- Inflation is affecting every food producer. Sugar, a big ingredient, is up 50% in 2023. People are buying fewer indulgences.
- PepsiCo borrows money to grow and operate, and higher interest rates make all borrowing more expensive.
- The ‘Ozempic effect’ is hurting every company that sells snack foods. Ozempic is the new miracle weight loss drug that makes you feel full sooner. A recent study by Morgan Stanley suggests that people on the drug snack half as much as they did before they started the regimen. Analysts are extrapolating this to the huge obesity problem in the world today and pointing the finger at fast food restaurants and pop and chip companies. Less snacks equals lower sales.
Here’s how we see it:
- Inflation will abate. In fact, it already is. Prices can’t go up forever and so they won’t.
- The same goes for interest rates. We may be near a peak already. Pepsi can, and has, adapted. It has huge cash flows from its daily sales and can manage its debt easily.
- The Ozempic effect is another matter. What if Ozempic is truly a wonder drug for obesity? It would truly be a miracle if it was, but I have heard this story before. Statins – the cholesterol-reducing drug marketed through names such as Lipitor – were the wonder dug of 20 years ago. Some cardiologists thought they were so good, we should add statins to our drinking water! We didn’t, but such was the mania for the new drugs. Statins have helped millions of people lower their risk of heart attack, but they haven’t affected Pepsi’s sales. GLP-1 drugs – Ozempic and its competitors – work partly by making you feel nauseous (20% of users experience this – drugs.com) and 70% of users stop using the drug within two years (BMJ Journals). And this doesn’t include the massive projected costs to the medical system if everyone starts taking it.
The rise of oil prices due to inflation and tension in the Mid-East has sent shares in many companies lower. PepsiCo shares may go lower still, depending on how long the conflict lasts.
Since we began as owners in the 1990s, Pepsi shares have experienced six major selloffs, including the one this year. All five before today have been close to the lows and were excellent times to add more shares. The decline this year looks very similar to those previous drops.
However, the world will continue enjoying cereal, juice, soda pop, and potato chips in the years to come, just as we always have. Our Dividend Value portfolios own shares in PepsiCo.
