Recommendation: HOLD Estimated Fair Value: $58.00-$77.00*

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1 Recommendation: HOLD Estimated Fair Value: $58.00-$77.00* 1. Reasons for the Recommendation Reason #1 PepsiCo s strongest asset is their snack portfolio. PepsiCo is the world s largest snack food company. Their snack portfolio is made up of two main brands; Frito Lay and Quaker. These segments of PepsiCo are both very well known in the snack industry and there is substantial brand loyalty for each. PepsiCo controls almost 40% of the US snack market and 30% of the non-us market. They have seen strong growth in their snack sales in emerging markets. In the 3 rd quarter snack sales in China, India, and Turkey increased 31%, 26%, and 22% respectively. Reason #2 Coca-Cola has always been the leader in the beverage industry. However, PepsiCo continues to be a strong 2 nd in the industry. PepsiCo does have a slightly larger beverage market share in the US market but still trails Coca-Cola globally. They have seen a downturn in sales due to the current economic conditions. Sales are steadily recovering boosted by strong growth in emerging markets. The acquisition of PepsiCo North American bottlers will allow them to cut down on their operating costs. It will also allow them to be more flexible in the creation routes to bring their products to the marketplace. Reason #3 PepsiCo continues to expand into more markets through the world. Growth in Asian and Eastern European markets are strong and are predicted to get even better in the future. Growth has slowed in the United States and Western European markets for all companies in the industry. PepsiCo has been proactive about moving into new markets and entering these markets before other companies. Beverage growth in emerging markets is imperative for PepsiCo in order to keep pace with Coca-Cola. Multiples After comparing P/E, P/B, and P/S ratios for the past 10 years against the S&P 500 it showed all three ratios were higher for PepsiCo during the time period. This could be an indication that PepsiCo is overvalued. However, there are similar trends when comparing the S&P 500 vs. the other companies in the industry. Also, all three of these ratios since 2005 have been decreasing at a faster rate then the S&P 500. PepsiCo s P/E, P/B, and P/S have decreased 37%, 39% and 52% respectively over the time period. While the S&P 500 P/E, P/B, and P/S have only decreased 20%, 31%, and 20% respectively during the same period. Their growth is slightly lower than the industry average but their growth was higher than the closest competitor Coca-Cola. The solid growth rate of PepsiCo combined with its P/E and forward P/E makes these ratios below the industry average, which could be an indication that PepsiCo is undervalued. The PEG ratio shows strong signs that PepsiCo is undervalued when compared to the other companies in the industry. Operating margins were lower then the industry average. The low operating margin is causing the EV/Sales ratio to be lower then industry average. 2. Company Analysis Strengths One of PepsiCo greatest strengths is they have a strong worldwide presence, which puts them in good position to take advantage of growth in emerging markets. PepsiCo is one of the largest snack and beverage companies in the world. PepsiCo is made up of 5 core brands: Pepsi, Frito Lay, Tropicana,

2 Quaker, and Gatorade. PepsiCo is a global company; they sell their products in over 200 countries. PepsiCo also has additional regional brands in countries all over the world. The companies largest markets are in the United States, Canada, and Mexico. PepsiCo breaks its company into 6 different segments: Frito-Lay North America, Quaker Foods North America, Latin America Foods, PepsiCo Americas Beverage, Europe, and Asia, Middle East & Africa. In a recent move PepsiCo acquired its North American bottlers. During 2010 PepsiCo issued $6 billion in new debt to finance this acquisition. Before these bottlers were independent, now they are a part of PepsiCo. Now that the bottling service is internal it gives PepsiCo more flexibility and profitably by cutting out a middleman. Bottling service outside of North America is still conducted by independent companies. This move is an industry-leading move that should keep PepsiCo at the top of the beverage industry with Coca-Cola. This move will add even more barriers for entry in this markets because of the costs associated with it. PepsiCo is continuously involved in research and development to create new products and product lines. They are always looking for new and better ways to compete; improvements in promotion of existing products and new products are key to competing with their competitors. Creating new products and improving promotion campaigns is a key reason why PepsiCo has been able to stay among the leaders in this industry. Recently, PepsiCo has been creating healthier products for its customer, meeting the demand created by the change in consumer preferences. Weakness PepsiCo has not been able to over take Coca-Cola as the number beverage manufacturer in the world. They has made great steps in trying to compete with Coca-Cola but has failed to replace them as number one in the industry. Coca-Cola is able to stay number one in the industry because they focus solely on beverages, while PepsiCo has diversified themselves over a variety of different product categories. PepsiCo has recently begun facing problems associated with the unhealthiness of their products. Consumers have started to look for healthier choices, which may hurt their sales in the future. Also, carbonated drinks have become a target for a fat tax if a tax such as this is implemented it would decrease sales and cut into their margins. Opportunities PepsiCo remains one of the global leaders in this industry because it has a well-rounded food and drink portfolio. Including oat, rice, grain based foods, carbonated and noncarbonated beverages. They continue to expand into different markets around the world. PepsiCo has a much stronger food portfolio than Coca-Cola, which gives them a competitive advantage in the food segment. However, Coca-Cola does have a significant advantage in the beverage market Following consumer trends is key to growth in this industry. PepsiCo has a good opportunity for growth by creating healthier alternatives to their product. Consumers now want low fat and low calorie snack products. PepsiCo has made steps in the right direction with its baked chips, Naked Juices, and other alternatives. However, the consumer still wants more healthy choices. PepsiCo is currently spending significant amounts of money for R&D to create these products. PepsiCo might want to consider acquiring some of the smaller healthy snack brands to strengthen their snack portfolio. Acquiring one of these small firms will also take one of their competitors out of the industry.

3 Threats PepsiCo has number of threats that could affect the profitability of the company. The first threat is volatility is commodity prices. Two of their main inputs are sugar and corn. These prices have been increasing in recent months; if these prices continue to increase PepsiCo will have to make some difficult choices to combat these fluctuations. The company will have to either pass the higher costs on to the consumers or let the increased prices cut into their margins. Passing on the commodity costs to their customers is a risky choice; it will help protect their margins. However, it may cause customers to be turned away from PepsiCo products. PepsiCo is only able to hedge 80% of their commodity risk, leaving them partly exposed. PepsiCo s recent acquisition of its bottlers increased their exposure to rising fuel costs. The risk of commodity fluctuation is a risk that all companies in the industry face. Unfortunately, for PepsiCo, they are not able to hedge all the risk associated with their business operations. During times commodity inflation PepsiCo operating expenses will greatly increase hurting their margins. Since PepsiCo operates in overseas markets they are subject to currency and political risk. Some of the Asian, African, and Latin American markets at times can have unstable political situations. Dictatorships, corruption, and political unrest are all things PepsiCo has to take into account while running their business in countries with these situations. Recent examples of this are the political uprisings in Egypt and Libya. Currency risk is a problem that all multinational companies have to worry about. 3. Industry Analysis The consumer staples sector is viewed as a defensive sector. This sector underperforms the S&P 500 during bull markets and outperforms during bear markets. The soft drink sub-industry is made up of three main beverage manufactures: PepsiCo, Coca-Cola Company, and Dr. Pepper Snapple Group. PepsiCo has the largest market share by revenues in the industry their share is 59%, then Coca-Cola with 36%, and in a distant 3 rd the Dr. Pepper Snapple Group with 5%. PepsiCo has the largest market share by revenue due their large snack portfolio, which Coca-Cola does not have. In the United States market PepsiCo makes up the largest share with 22% of the beverage market, Coca-Cola is 2 nd with 20% and Dr. Pepper Snapple Group with 10%. PepsiCo and Coca-Cola are the two main companies in the industry. Coca-Cola is the largest beverage company in the industry due to their large global presence. This industry continues to see strong growth through out the world. There is little move for growth in the United States and Western European markets due to high competition and over saturation of the market. PepsiCo and Coca-Cola are looking to emerging markets in Asia, South America, and Eastern Europe for future growth. China, India, and Brazil are three of the world s fastest growing economies. These countries offer good long-term opportunities for growth in the future. Increasing commodity prices are hurting the companies in this industry. The components for their beverage and food products continue to rise. In some cases the companies are being forced to raise the prices on some of their products. Raising prices may cause a decrease in the volume of sales, thus creating narrower margins. Agricultural prices are not the only rising commodity hurting the industry; increasing fuel costs are making transportation costs to go up. The increases in operating expenses are causing the companies to become more efficient. Cutting costs wherever possible to make their companies as profitable as possible. Prices increases may come in the form of smaller package sizes. An example of this is companies turning to the 16.9 oz. (500ml) bottles instead of the traditional 20oz bottles. Companies in the industry are looking for new and creative ways to market their products. Social media and Internet marketing offer cheap and effective ways of reaching consumers. Especially, reaching younger consumers. Companies are marketing their products using Groupon, Facebook, and Twitter. While moving forward with alternative forms of advertising, companies in this industry are still using

4 traditional forms of advertising to market their products. An example of this would be Super Bowl commercials, where companies are still spending nearly $3 million for a 30 second ad. PepsiCo and Coca- Cola are aggressively marketing to younger generations trying to create brand loyalty and lifelong customers. The industry is starting to create more healthy drinks and snacks. Consumers are now demanding more choices, especially, consumers in the North American and European markets. The companies in the industry have responded by introducing diet sodas, zero calorie drinks, and more nutritious snacks. Also, the industry has been introducing new healthy fruit drinks. Using less sugar and fattening ingredients has seen a good response from consumers who are looking for healthier choices. There is still much room for growth in this healthy drink and snack segment. This new consumer trend has a strong presence is many markets and it is important for all companies in this industry to be looking forward by creating new products to fulfill the customers demand. The recent downturn the economy has hurt the companies in this industry. PepsiCo and Coca- Cola have weathered the poor economy and are poised to for strong growth as the economy continues to recover. The outlook for the industry is strong with continued growth in emerging markets. The economies of the emerging markets are growing at a much faster rate then the counties in the West. It is imperative that the industry focuses on growing in these markets. China and India make up almost 1/3 of the world s population and these countries are relatively untapped. PepsiCo and Coca-Cola are working hard to grow their companies in these countries and trying to create brand loyalty for continued future sales.

5 Appendix: Methodology* Estimated calculated using Discounted Cash Flows (DCF), specifically the Free Cash Flows to the Firm (FCFF). Two different scenarios were taken into account. The first was a high growth period, the factors that were taken into account were continued rapid growth in emerging markets (i.e. China and India) and a quick recovery in US and European markets. In the slower growth time period the factors taken in account were a possible double dip recession and reduced growth in emerging markets. The high growth rates were between 9.5%-7% during the 7 year time period. The low growth rates were between 3.5%-5.5% during the same time period. Appendix: Multiples Comparable Firms Sources: Google Finance and Yahoo! Finance *Growth rates are average growth rates from analysts covering the stock. The growth rate used in the DCF are based on fundamental growth rates

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