Analyst:

Shane Connor 937-657-7371

connor.87@osu.edu

Investment Conclusion-BUY PepsiCo’s shares are currently undervalued at 14.8x 2009 EPS. Declining commodity costs, strong international sales, and Frito-Lay should drive earnings. Bottler integration should be seen as a major positive for Pepsi Americas Beverages. Key Points: • As the economy recovers, demand

should pick up across all business segments.

. • Strong international growth will continue

as PepsiCo leverages its brands and marketing power.

• Frito-Lay revenue should continue to

grow as PepsiCo offers more value to consumer than private labels.

• Concerns over declining demand for

carbonated soda beverages are overstated. Bottler integration should put PepsiCo is the driver’s seat.

• Since PepsiCo successfully operates

many of its international bottlers, share-holders should be confident in the company’s ability to run U.S bottling operations.

Beverages PEP-BUY Current Price $56.56 1-year Price Target $70.04 52 Week Range $43.78-75.25 Market Cap 88,800m Diluted Shares Outstanding 1,570m Average Daily Volume 9.86m Dividend Yield 3.1% 2008A 2009E 2010EConsensus 3.21 3.70 4.07 High 3.80 4.16 Low 3.65 3.91 SIM Est. 3.76 4.00 FW P/E Ratio 20.1x* 15x 14.1x *2008 average (in millions) 2009E 2010E FY Sales Est. 43,251 44,361 48,057 Price Sales 2.33* 1.98 1.85

PepsiCo, Inc. Recommending: Buy NYSE-PEP August 18, 2009

2

Company Profile1: PepsiCo's beverage business was founded in 1898 by Caleb Bradham, the pharmacist

who first formulated Pepsi-Cola. PepsiCo, Inc. was founded in 1965 when Pepsi-Cola

and Frito-Lay merged. Today, PepsiCo (PEP) manufactures, markets, and sells a

variety of salty, convenient, sweet, and grain-based snacks; carbonated and non-

carbonated beverages; and foods in approximately 200 countries. Their largest

operations are found in North America (United States and Canada), Mexico, and the

United Kingdom. PepsiCo currently has six business segments: Frito Lay North America

(FLNA); Quaker Foods North America (QFNA); Latin America Foods (LAF); Pepsi

Americas Beverages (PAB); United Kingdom & Europe (UKEU); and, Middle East,

Africa & Asia (MEAA).

Business Segments2: Frito-Lay North America (FLNA: 29% of 2008 revenue) FLNA manufactures, markets, sells, and distributes branded snacks to independent

distributors and retailers. Major brands include: Lay’s®, Doritos®, Tostitos®, Cheetos®,

Fritos®, Ruffles®, Rold Gold®, Sunchips®, Grandma’s®, Cracker Jack®, Smartfood ®,

TrueNorth™, and several others totaling almost 400 different products within these

brands. FLNA comprised 37% of PepsiCo’s 2008 operating profits, the highest of the six

business segments.

Pepsi Americas Beverages (PAB: 25% of 2008 revenue)

PAB consists of brands which produce carbonated soft drinks, juices and juice drinks,

ready-to-drink teas and coffee drinks, isotonic sports drinks, bottled water and

enhanced waters. Major brands distributed by this business segment include Pepsi,

Mountain Dew, Gatorade, Tropicana, Sierra Mist, Mirinda, Propel, Dole, Amp, SoBe,

Naked, and Izze. PAB comprised 26% of PepsiCo’s 2008 operating profits.

1 2008 10-K 2 2008 10-K

3

UK & Europe (UKEU: 15% of 2008 revenue) The UK & Europe segment of PepsiCo manufactures, markets, and sells both snacks

and beverages. In addition to Frito-Lay brands, PepsiCo also owns European-specific

brands. The most dominant is Walkers®, the leading salty snack brand by market share

in the United Kingdom. PepsiCo sells most of its domestic beverages plus a few

European-specific beverage brands. Last March, PepsiCo acquired 75% of Russian

juice maker Lebedyansky®. PepsiCo stated Lebedyansky® production volumes grew 30-

fold from 1999 to 2007 and quadrupled market share in the same period. Unlike U.S.

PepsiCo, the UK and European business segment has operated most of its bottlers and

distributors for many years. UKEU comprised 10% of PepsiCo’s 2008 operating profit.

Latin America Foods (LAF: 14% of 2008 revenues) LAF manufactures, markets, and sells both salty and sweet snacks under many of same

Frito-Lay North America brand names. LAF PepsiCo uses contracted distributors and

manufacturers for its Quaker brands distribution. Pepsi also owns popular Gamesa®

and Sabritas®, snack companies which hold significant market share in Latin America.

LAF comprised 11% of PepsiCo’s 2008 operating profit.

Middle East, Africa, and Asia (MEAA: 13% of 2008 revenue) PepsiCo MEAA markets and sells PepsiCo’s branded snacks and cereals. These

products are sold to consolidated businesses and non-controlled affiliates. In addition,

PepsiCo MEAA markets and sells its beverages to authorized bottlers, independent

distributors, and retailers. Similar to UKEU, PepsiCo MEAA owns and operates many of

its bottlers and distributors. MEAA comprised 9% of PepsiCo’s 2008 operating profit.

Quaker Foods North America (QFNA: 4% of revenue) QFNA manufactures (or uses contract manufacturers), markets, and sells cereals, rice,

pasta and other branded products. QFNA’s products include: Quaker Oats®, Life® and

Cap N’ Crunch® cereals, Aunt Jemima® syrups, and Rice-A-Roni®. These products are

sold through distributors and retailers. QFNA comprised 7% of PepsiCo’s 2008

revenues.

4

Figure 1

PepsiCo’s Major Name Brands

5

PEP Revenue Line Fit Plot

-8.00%-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%

-10.00% 0.00% 10.00% 20.00%

PEP Revenue

GDP

GDP

Revnue

Macro Economic Factors Figures 2.1, 2.2, 2.3

PepsiCo is part of the consumer staples

sector – which tends to perform well even

when the country is viewed to be in a

recession. Most economists agree the

U.S. is returning to growth and positive

GDP should be reported sometime later

this year. A recent Wall Street Journal

survey indicates many economists feel

that GDP could turn positive as early as

this quarter. I believe PepsiCo will benefit

from an improving macro picture and

lower commodity costs.

GDP growth is an obvious positive

economic sign. I think PepsiCo will

undoubtedly benefit from this growth. To

understand the extent of PepsiCo’s

correlation with the GDP, I ran a series of

regressions. The sample size was comprised of the past ten quarters. I chose this

sample to determine how PepsiCo is performing in the current environment. First, I ran

a regression comparing GDP and

PepsiCo revenues. The correlation was

positive, but was not very strong (.64).

Next, I ran regressions using volume as

this excludes price increases and foreign

exchange. My results were surprising.

GDP and PepsiCo volume growth

showed a correlation of .84. I thought this

quite high considering PepsiCo is

regarded as a consumer staple.

PepsiCo Line Fit Plot

-8.00%-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%

-2.0% 0.0% 2.0% 4.0% 6.0%

PepsiCo

GD

P GDP

PepsiCoVolume

PAB Line Fit Plot

-8.00%-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%

-8.0%

-6.0%

-4.0%

-2.0%

0.0% 2.0% 4.0%

PAB

GD

P GDP

PABVolume

6

Lastly, I ran a regression comparing GDP and PAB volume growth. I did this as I

believe PAB is not only struggling due to increased competition in the beverage

industry, but also due to a macro slowdown. The correlation between GDP and PAB

volume was .87. This supports my conclusion that PAB problems can also be attributed

to the economy.

Figure 4

PepsiCo will benefit from the fall in commodity prices in the latter part of 2008.

No commodity represents more than 10% of PepsiCo’s COGS, but together they

represent a significant portion. PepsiCo enters into futures contracts in order to hedge

themselves against commodity prices. During conference calls, management indicated

many of these contracts were entered into last summer. I believe PepsiCo will benefit

when these contracts expire and they will be able to enter into new contracts at much

lower prices. Figure 5 shows the significant drop off in commodity prices since last year.

GDP PEP Revenue PepsiCo Volume PAB VolumeGDP 1PEP Revenue 0.643959678 1PepsiCo Volume 0.837758933 0.88213954 1PAB Volume 0.867067187 0.805432412 0.923542917 1

Figure 5 (Source USDA)

7

Overall, PepsiCo’s input costs should decrease in the second half of this year. I

believe food commodity prices should remain low as the supply side reports good

outputs. According to the USDA, estimated corn crop production is 12.761 billion

bushels. Providing this estimate is accurate, it would be the second largest recorded

corn crop. Continued low commodity costs will increase PepsiCo’s margins.

Sector Outlook Consumer Staples have underperformed the S&P 500 by 8% YTD. Much of this can be

attributed to investors moving funds out of defensive sectors and into more cyclical

sectors. Investors are more willing to take on risk in anticipation of an economic

recovery. In Figure 6 different valuation metrics are shown on an absolute basis.

Figure 6 Absolute Basis High Low Median Current Analyst Opinion

P/Trailing E 20.8 12.2 18.9 14.2 Undervalued P/Forward E 19.2 12.1 17.9 13.8 Undervalued P/B 5.2 2.6 4.5 3.3 Undervalued P/S 1.3 0.6 1 0.7 Undervalued P/CF 14.5 8.8 13.3 10.3 Undervalued Source: Thompson Baseline

Currently, all of the valuation metrics seem to undervalue consumer staples. This

can be expected due to the recent movement to more cyclical sectors.

In Figure 7 the same valuation metrics are shown relative to the S&P 500. This

shows that Consumer Staples appear to be more inline with historical valuation.

Figure 7

Relative to SP500

High Low Median Current Analyst Opinion

P/Trailing E 1.2 0.94 1.1 0.96 Undervalued P/Forward E 1.3 0.86 1.1 0.89 Undervalued P/B 2 1.4 1.7 1.6 InlineP/S 0.9 0.6 0.7 0.8 InlineP/CF 1.4 1 1.3 1.2 Inline Source: Thompson Baseline

8

In conclusion, I think Consumer Staples are a necessary part of any portfolio

given current uncertainty in equity markets. Consumer Staples could also perform very

well in a growing global economy as emerging markets begin to spend money on more

on staples. The beverages industry is a good example of an industry which could

benefit from a growing global economy.

Figure 8 (Source: S&P industry survey)

Beverages Industry Historically, the beverages

industry has been one of the

more cyclical industries

within Consumer Staples. It

trades at higher valuation

multiples since beverage

companies offer more

growth than most other

Consumer Staples. A major concern for the industry is declining demand for carbonated

soft drinks (CSDs). Consumers have been opting for healthier options such as water

and energy boosting drinks.

Figure 8 shows CSDs consumption declined 3.1% in 2008 compared to 2007.

Flavored and enhanced water and energy drinks had the greatest gains. This data

appears to confirm a consumer shift from CSDs. If the trend continues, beverage

companies will be forced to come up with innovative new products to spur demand.

A major risk for the beverage industry is the proposed soda tax. Lawmakers are

debating the idea of a soda tax to help pay for healthcare reform. Early reports indicate

the tax could be as much as three cents per twelve ounces. Currently, the soda tax is

simply one of a hundred different ideas to pay for healthcare reform. However, if

passed, it would constitute a major disadvantage to the beverages industry.

9

Company Analysis “The Deal” On August 4, 2009, PepsiCo struck a deal to buy its two largest bottlers. The acquisition

of Pepsi Bottling Group and Pepsi Americas will give PepsiCo control of 80% of its U.S.

beverage distribution. The deal will cost PepsiCo $7.8bn and shareholders will have the

option to choose cash or PepsiCo stock. This may be confusing to some as ten years

ago PepsiCo completed a spin-off of these two companies.

In 1999, PepsiCo divested it two largest bottlers but continued to hold minority

shares in both. PepsiCo felt this would increase shareholder value as profits came

primarily from fountain beverages and concentrated sales. PepsiCo believed bottling

was too capital intensive and the margins were not large enough. After the divestiture,

PepsiCo’s operating margins and ROIC increased. Coke followed Pepsi’s lead and

divested its bottlers as well.

However, the beverage industry went through a change the years after the spin

off. There were new small “niche” companies (vitamin water), more juices, teas, and

energy drinks entering the market. In addition, CSD (carbonated soft drink) demand was

weakening as consumers looked for healthier alternatives. PepsiCo responded by

developing healthy alternatives, but often lagged behind in bringing these products to

market. The lag was caused by bottlers who relied on heavy volumes to make a profit

and did not want to experiment with “niche” products. Without a competitive presence

from PepsiCo or Coke, many companies easily entered the industry and were able to

carve out significant market share.

PepsiCo quickly realized that in order to grow in the beverage industry it would

need to offer new products. An initial offer of $6bn by PepsiCo was turned down by the

bottlers. Pepsi Bottling Group stated the deal undervalued the potential $750-$850

million in synergies. In the initial offer PepsiCo estimated synergies of only $200 million.

PepsiCo now says that there should be $250 million in synergies.

Is this a positive?

Only time will tell, but I believe bottler integration is necessary to grow PAB (Pepsi

Americas Beverages).

10

Benefits

• PepsiCo, through Frito-Lay, has many of the same distribution channels as its

bottlers

• Duplicate jobs can be eliminated

• PepsiCo can now experiment with “niche” products and package innovation

• Integration should improve PepsiCo’s ability in bring new products to market

• PepsiCo may be able to offer bundled items

• Gatorade and Aquafina water 24pk

Risks

• Unanticipated charges or poor performance relating to the integration and operation

of Pepsi Bottling Group and Pepsi Americas

• PepsiCo has owned its international bottlers since it expanded to those markets. I believe PepsiCo should be able to leverage this operational knowledge to efficiently integrate and operate its U.S. operations

Figure 93

Business Segment Analysis Frito-Lay North America (FLNA) Analysis PepsiCo holds a 39% market share in the

U.S. savory food snacks market4. In the last

three years FLNA has delivered high single

digit revenue growth and low single digit

volume growth. In mid-2008, PepsiCo

passed price increases through to

consumers due to higher commodity costs.

Subsequently, revenue continued to grow

but volume decreased as the economy

3 Company Reports 4 Company Reports

11

weakened and consumers traded down to private labels. In 2009, PepsiCo has pulled

back somewhat on the price increases they implemented in 2008, and have introduced

the “20% more” campaign promoting more chips per bag. Consumers were quick to

recognize the added value as FLNA reported a 3% volume growth and more than an

8% revenue growth in 2Q09. I believe this is PepsiCo’s most important business

segment. Brands such as Frito-Lay, Doritos, and Ruffles are household names which

offer strong, predictable demand. PepsiCo distributes these products through its Direct

Store Delivery (DSD) network – a system that delivers Frito-Lay products directly to

retailers. PepsiCo works with individual retailers to improve inventory management and

reduce costs. This unique relationship is a best-in-industry practice that PepsiCo should

be able to effectively leverage when they begin distributing their own beverages.

Pepsi Americas Beverages (PAB) Analysis Figure 105 PAB is often perceived as PepsiCo’s

“problem child” due to decreasing sales

volume. These declines can be primarily

attributed to a more health conscious

consumer and increased competition in the

beverages space. Health conscious

consumers have been gravitating more

towards water, low calorie beverages, teas,

and juices. PepsiCo has responded by

introducing low calorie alternatives as well

as by acquiring smaller beverage

companies (i.e. Naked Juices) that

compete in this space.

A secondary reason for volume

decline is increased competition in the beverage industry. The industry now includes

several niche products – e.g., energy drinks, enhanced waters, teas, and specialty

5 Company Reports

12

juices. PepsiCo has tried to bring similar products to market, but has not been very

successful. Forestalling their efforts was their relationships with the bottlers who rely on

large volume production that niche products generally cannot deliver. I believe

PepsiCo’s recently announced acquisition of the Pepsi Bottling Group and Pepsi

Americas will enable them to restore long term growth in this segment.

Within Pepsi American Beverages the Gatorade product has struggled most,

down an estimated -18%6 in second quarter volume. Gatorade is a premium priced

product which depends on consumer activity. During the second quarter conference call

CEO Indra Nooyi noted construction workers were no longer buying multiple bottles of

Gatorade on the way to work as they did prior to the recession. This is a good example

of the product’s dependence on consumer activity. Furthermore, with high

unemployment, premium priced products like Gatorade tend to struggle.

PepsiCo recently rebranded Gatorade as “G”. Initial reactions have been mixed

but PepsiCo has stated this is a long term strategy. In addition, I believe Gatorade or

“G” will be one of the benefactors of the bottler’s integration. PepsiCo will be able to

bring to market more flavors, bottle sizes, and bottle styles. Overall, I think Gatorade’s

weakness will be short lived. As consumer activity recovers and new products come to

market, Gatorade will return to strong growth.

United Kingdom & Europe (UKEU) Analysis

In 2008, snack volume was up 6% compared to the previous year. Walkers® had low

single digit volume increases in most regions and acquisitions added to the volume

increase. UKEU beverage volume was up 17% compared to the previous year. Newly

acquired Lebedyansky® contributed 16% growth and carbonated soft drinks achieved

modest volume gains.

These results clearly illustrate the international growth PepsiCo is experiencing. I

believe PepsiCo is unfairly classified as a mature company. PepsiCo investors receive

consistent domestic performance, but are also exposed to PepsiCo’s growing

international franchise.

6 Beverage Digest

13

PepsiCo is committed to international growth both organically and though

acquisitions. Pricing, brand recognition, and distribution power enable PepsiCo to enter

new markets and immediately become the leader. I believe UKEU will continue to

outpace other segments as PepsiCo enters fast growing emerging markets where

population and growth are increasing.

Latin American Foods (LAF) Analysis

The LAF business is currently experiencing slower growth than MEAA and UKEU

because PepsiCo been in the LAF market much longer. This segment reported a 3%

increase in volume, primarily coming from an acquisition in Brazil. Mid single digit

declines for Sabritas® was offset by mid single digit increases for Gamesa®. I believe

PepsiCo has less room for distribution growth than it once had and as a result will now

focus on small acquisition growth, new product offerings, and market growth. For

example, PepsiCo announced this month it was acquiring Brazil’s top coconut water

company.

Middle East, Africa, and Asia (MEAA) Analysis MEAA is PepsiCo’s fastest growing segment. Double digit volume growth has been

recorded in the past three years. In 2008, double digit and mid digit growth was

recorded by China and India, respectively. PepsiCo’s expansion into these markets

came much later than rival Coke; however, PepsiCo’s brands have been very well

received. This relative underexposure will allow PepsiCo to increase market share by

simply increasing distribution. Further growth will come as acquisitions are made and

brand awareness increases.

Quaker Foods North America (QFNA) Analysis

Although QFNA is PepsiCo’s smallest segment by revenue, it is a stable performer. In

2008, QFNA reported a 1.5% volume decline compared to the previous year. This was

14

largely due to lower sales of Quaker Oatmeal and ready-to-eat cereals. This segment is

not as susceptible to major volume swings and seems to chug right along without much

attention. PepsiCo is more concentrated on its international growth businesses than

QFNA. I believe QFNA has serious potential and could be one of the only segments that

can take advantage of a more health conscious consumer. New product offerings under

a powerful brand name like Quaker would be very successful.

It’s not just a battle over taste… PepsiCo (PEP) vs. Coke (KO)

The battle between Pepsi and Coke is not just over taste but also over investor dollars.

When building a portfolio, investors and portfolio managers must determine which

company offers better value. For example, when PepsiCo reports its earnings, Coke

must either match or beat Pepsi’s earnings and vice versa. If either falls short, it often

times negatively impacts their stock price. This is a fairly unique situation as there are

very few industries where such large market shares are at stake. In Figure 11, I have

determined who is better positioned for long term success.

15

Figure 11

Source: S&P Data Insight (OSU Libraries)

Battle Grounds Pepsi Coke Advantage

Forward P/E 15.1x 16.1x

ROE 36.20% 27.20%

P/S 2.7x 3.6x

Dividend Yield 3.05% 3.60%

Efficiency Inventory Turnover- 7.8, Asset Turnover 1.2, Average Collection Period (days)- 37.8

Inventory Turnover- 4.7, Asset Turnover- .76, Average Collection Period (days)- 36.1

Product Diversification

PepsiCo has stong snack, food, and beverage brands. Its strongest brands might be in snacks (Frito-Lay)

Coke is strictly beverages

International ExposureInternational sales are approximately 40% of revenues

International sales are approximately 70% of revenues

WINNER

16

Income Statement and Segment Revenue (Appendix 1,2)

PepsiCo’s revenue over the last five years has been growing at a compounded annual

growth rate of 10.4%. This impressive performance has been mainly driven by organic

growth not acquisitions. (PepsiCo’s last major acquisition was Quaker Oats in 2001)

Going forward, I forecasted 2.57%, 8.33%, and 7.58% revenue growth in years 2009,

2010 and 2011, respectively. Company guidance for 2009 was 6-9% revenue growth

excluding currency. In the second quarter, PepsiCo stated that 2009 revenue would be

negatively affected by currency due to the strong dollar in the first half of the year.

Therefore, I believe that my forecast (2.57%) is within reason.

Operating margins should move higher in 2009 as PepsiCo’s existing commodity

contracts expire. This should boost operating margins in the second half of this year.

These effects are taken into account on a per segments basis in my forecasts.

Balance Sheet Analysis (Appendix 4) After analyzing the balance sheet no major red flags were found. The big jump in debt

from 2007 to 2008 could be attributed to the anticipated acquisition of Pepsi Bottling

Group and Pepsi Americas. Other acquisitions in 2008 (Lebedyansky) were also funded

partially though debt. I believe debt should not be a concern as PepsiCo sill maintains a

Net debt/EBITDA ratio of .6. PepsiCo is also able to borrow at very attractive rates given

their A+ S&P rating.

17

Valuation Analysis I utilized three different valuation techniques to determine a price target for PepsiCo

(PEP): (1) Discounted Cash Flow model; (2) Historical valuation multiple model; and (3)

Forward EPS estimate.

(1) DCF Valuation (Appendix 3) Assumptions

• 10% discount rate used, which is relatively high for a consumer staple

• 3.5% terminal growth as it represents historical GDP

• Long term revenue growth remains around 8% due to strong international demand; it

eventually reverts back to 3.5% terminal rate

• 17.5 % operating margin represents the 5 years average

• 3.8 % depreciation and amortization represents historical average

• Working capital gradually decreases as revenue growth slows

I came up with an intrinsic value of $72.82 using the discounted cash flow model.

Additionally, I performed a sensitivity analysis to determine the effects of using different

discount rates and terminal growth rates. Figure 12

Sensitivity Analysis- Implied Equity Value ($)Terminal Discount Rate

Terminal FCF 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50%3.00% 82.08 75.35 69.59 64.60 60.25 56.55 53.02 49.993.50% 86.92 79.28 72.82 67.29 62.51 58.34 54.66 51.394.00% 92.72 83.92 76.59 70.40 65.10 60.51 56.50 52.974.50% 99.82 89.49 81.05 74.02 68.08 62.99 58.58 54.735.00% 108.69 96.30 86.40 78.30 71.55 65.85 60.97 56.74

Sensitivity Analysis- Upside (%)Terminal Discount Rate

Terminal FCF 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50%3.00% 45.1% 33.2% 23.0% 14.2% 6.5% 0.0% -6.3% -11.6%3.50% 53.7% 40.2% 28.7% 19.0% 10.5% 3.1% -3.4% -9.1%4.00% 63.9% 48.4% 35.4% 24.5% 15.1% 7.0% -0.1% -6.3%4.50% 76.5% 58.2% 43.3% 30.9% 20.4% 11.4% 3.6% -3.2%5.00% 92.2% 70.3% 52.8% 38.4% 26.5% 16.4% 7.8% 0.3%

18

The results (Figure 12) show the downside risk is not present until a 12%

discount rate is used. I believe my 10% rate is very conservative and should provide a

good margin of safety. When I determined my discount rate I started at a rate of 9%. I

then added 50 bps for risks associated with the bottler integration. I also added an

additional 50bps for risks associated with a declining beverage demand. A 10%

discount rate is much higher than the rate the CAPM determined.

(2) Comparable Valuation Multiple Model From the comparable valuation multiple model analysis I determined the value of PEP is

$67.31. This results in a 21% upside from the PEP’s current share price. I arrived at

this price by averaging the target multiples for each valuation metric. I tried to show

mean reversion when choosing my target multiples. I also considered the various risk

and rewards associated with PepsiCo. Additionally, as the economy recovers and

investors move back into the market, multiples will gradually increase. I feel these

multiples are realistic over a one year time period.

Figure 13

Target Price

A. B. C. D. E. F. G. H.P/Forward E

22.7 13.1 19.8 14.8 17.5 3.76 $65.80

P/S 3.5 1.8 3.1 2.1 2.5 32.47 $81.71 P/B 7.7 5.5 6.7 7.4 7.2 7.74 $55.71 P/EBITDA 14.72 8.55 12.61 9.2 10.5 6.22 $65.31

P/CF 19.6 10.4 17.1 12.2 13 4.69 $68.00 Average $67.31

Current Target Multiple

E, S, B, etc/Share

Absolute Valuation

High Low Median

As of 8/3/09 Source: Thompson Baseline

(3) Forward Price/Earnings

19

Finally, I wanted to come up with a value for PEP that would include the bottler

integration. PepsiCo stated the bottler integration would result in $250 million in

synergies and be .15c accretive to EPS by 2012. I feel synergies will be greater and

occur sooner than stated. (Pepsi Bottling Group said there was $750-$850 in

synergies.) However, I cannot blame PepsiCo for being conservative given integration

uncertainty. I arrived at my target price of $70.53 by adding .10c onto my 2010 EPS and

applying a 17.5x P/E multiple. This price target should be included in my 1- year target

since investors will consider PepsiCo’s future earning power.

Figure 14

2010 EPS Accretive EPS 2010 EPS Target Multiple Price Target$3.90 + .10c = 4.00$ x 17.5x 70.00$

Forward Multiple Price Target

Valuation Recap • DCF price target: $72.82

• Comparable Valuation Multiple Model: $67.31

• Forward Price/Earnings: $70.00

I averaged all three price targets to arrive at a one year of $70.04. The implied upside

for using this price tag and adding in the dividend yield is 27%.

Risks to Price Target

• Unanticipated charges relating to the integration of Pepsi Bottling Group and Pepsi

Americas

• Continued weak demand for carbonated soft drinks

• Enactment of soda tax

• Foreign Currency and commodity price volatility

20

Executive Summary

• I am assigning a BUY rating with a $70.04 1-year target price. • This target price implies 27% upside including the dividend.

I believe PepsiCo’s shares are currently undervalued and will offer good, long

term appreciation. PepsiCo currently trades at 14.8x my 2009 EPS estimates. This

represents a 34% discount compared to their historical forward P/E of 19.8x. In addition,

PepsiCo’s Price/Sales, Price/EBITDA, and Price/Cash Flow all trade at a discount to

their respective historical medians. My DCF model values PepsiCo’s shares at $72.58

which implies an upside of 28%. I included all risk factors, consumer trends, and macro

economic factors when generating forecasts. My estimates are conservative and

earnings upside is very possible. Some may argue current valuation is warranted given

the weak demand for soft drinks. However, I perceive this concern to be overstated and

believe bottler integration within PAB will mark a turning point for this business segment.

Short term projections: PepsiCo will benefit from a macro recovery. My

research shows a positive correlation between PepsiCo’s volume and the GDP.

Therefore, as GDP begins to rebound, PepsiCo’s volume should pick up.

PepsiCo will also benefit from lower commodity costs. I anticipate this margin

expansion to occur in the second half of this year as previous commodity contracts

expire and PepsiCo is in a position to renegotiate them at lower prices.

PepsiCo remains an attractive investment despite the record rally from March

lows. Since March, the S&P 500 is up almost 50%, but PepsiCo is up only 9%. PepsiCo

is well positioned, therefore, to be a beneficiary as investors hunt for remaining

bargains.

Long term projections: A majority of PepsiCo’s growth will come from two

sources: (1) international growth and correlating market penetration, (2) Pepsi Americas

Beverages, and (3) Frito-Lay North America

21

PepsiCo’s low international exposure relative to Coke is as an opportunity for the

company to aggressively expand and grow international sales by leveraging its brands

and marketing power. In addition, international acquisitions, e.g., Lebedyansky, and

market penetration, especially in the MEAA business segment, should offer long term

growth.

Pepsi Americas Beverages will become a long term growth vehicle for the

company. After the acquisition of Pepsi Bottling Group and Pepsi Americas, PepsiCo

will be on course to level the playing field with its smaller “niche” competitors. PepsiCo

will have the ability to develop and produce products that can go head-to-head with

these competitors who have been eroding market share.

Frito-Lay growth should continue as PepsiCo is able to leverage its dominant

brand names. Private label penetration has been a concern but PepsiCo has regained

the upper hand by offer “20% more per bag”. This campaign should not significantly cut

into PepsiCo’s margins because of lower commodity costs. In addition, price increases

implemented in 2008 will benefit PepsiCo.

Finally, I would not discount Quaker Foods North America (QFNA). If PepsiCo

targets the health conscious consumer and cleverly markets / leverages the popularity

of the brand as well as its products, this could be a business segment that brings

PepsiCo long term, sustainable growth.

22

Appendix 1 Pro Forma Income Statement

PepsiCo Income Statement FY2011E FY2010E FY2009E FY2008 FY2007 FY2006 FY2005 FY2004Net Revenue 51,700 48,057 44,361 43,251 39,474 35,137 32,562 29,261Cost of Sales SG&A Amort. of intangible Segment Operating Profit 9,561 9,154 8,436 7,942 7,923 7,240 6,764 6,098Corp- net impact of mark-mkt on commodity hedges -287 -92 295 -346 19 -18 Corp-Other -905 -841 -949 -661 -772 -720 -780 -839Operating Profit 8,370 8,222 7,781 6,935 7,170 6,502 5,984 5,259 Operating Profit Margin 16.19% 17.11% 17.54% 16.03% 18.16% 18.50% 18.38% 17.97%Bottling equity income 336.0 312.4 288.3 374 560 553 495 380Interest Exp. -439.45 -408.48 -399.25 -329 -224 -239 -256 -167Interest Inc 77.55 72.09 66.54 41 125 173 159 74Income before Taxes 8,344 8,198 7,737 7,021 7,631 6,989 6,382 5,546Provision for Taxes 2336.38 2295.34 1934.32 1879 1973 1347 2,304 1,372Net Income 6,008 5,902 5,803 5,142 5,658 5,642 4,078 4,174Net Income per Common Share

Basic w/o bottlers 4.07 3.93 3.80 3.26 3.48 3.42 2.45 2.45Diluted w/o bottlers 4.04 3.90 3.76 2.21 3.41 3.34 2.41 2.41

Consensus 4.33-3.90

3.80-3.60

23

Appendix 2 Segment Revenue and Operating Profit

FY2011E FY2010E FY2009E FY2008 FY2007 FY2006 FY2005

PepsiCo Americas FoodsFrito-Lay North America 15,318 14,588 13,508 12,507 11,586 10,844 10,322Quaker Foods North America 1,979 1,959 1,921 1,902 1,860 1,769 1,718Latin America Foods 6,644 6,095 5,541 5,895 4,872 3,972

PepsiCo Americas BeveragesPepsiCo Americas Beverages 11,022 10,598 10,390 10,937 11,090 10,362 9,146

PepsiCo International 11,376UK/Europe 8,551 7,635 6,757 6,435 5,492 4,750 -Middle East/Africa/Asia 8,186 7,181 6,244 5,575 4,574 3,440 -

Total Revenue 51,700 48,057 44,361 43,251 39,474 35,137 32,562

PepsiCoSegment Profit

PepsiCo Americas FoodsFrito-Lay North America 3,676 3,574 3,309 2,959 2,845 2,615 2,529Quaker Foods North America 604 637 586 582 568 554 537Latin America Foods 1,096 1,006 887 897 714 655 -

PepsiCo Americas BeveragesPepsiCo Americas Beverages 2,094 2,014 2,026 2,026 2,487 2,315 2,037

PepsiCo International 1,661UK/Europe 1,048 954 878 811 774 700 -Middle East/Africa/Asia 1,044 969 749 667 535 401 -

Operating Profit 9,561 9,154 8,436 7,942 7,923 7,240 6,764

Sales Growth (YOY)PepsiCo Americas Foods

Frito-Lay North America 5.00% 8.00% 8.00% 7.95% 6.84% 5.06% 7.97%Quaker Foods North America 1.00% 2.00% 1.00% 2.26% 5.14% 2.97% 12.58%Latin America Foods 9.00% 10.00% -6.00% 21.00% 22.66% - -

PepsiCo Americas BeveragesPepsiCo Americas Beverages 4.00% 2.00% -5.00% -1.38% 7.03% 13.30% 10.02%

PepsiCo International 15.35%UK/Europe 12.00% 13.00% 5.00% 17.17% 15.62% - -Middle East/Africa/Asia 14.00% 15.00% 12.00% 21.88% 32.97% - -

Total Revenue 7.58% 8.33% 2.57% 9.57% 12.34% 7.91% 11.28%Guidance ex. Currency 6-9%

Operating MarginPepsiCo Americas Foods

Frito-Lay North America 24.00% 24.50% 24.50% 23.66% 24.56% 24.11% 24.50%Quaker Foods North America 30.50% 32.50% 30.50% 30.60% 30.54% 31.32% 31.26%Latin America Foods 16.50% 16.50% 16.00% 15.22% 14.66% 16.49% -

PepsiCo Americas BeveragesPepsiCo Americas Beverages 19.00% 19.00% 19.50% 18.52% 22.43% 22.34% 22.27%

PepsiCo International 14.60%UK/Europe 12.25% 12.50% 13.00% 12.60% 14.09% 14.74% -Middle East/Africa/Asia 12.75% 13.50% 12.00% 11.96% 11.70% 11.66% -

Operating Profit 18.49% 19.05% 19.02% 18.36% 20.07% 20.61% 20.77%

24

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25

Appendix 4 (Source: S&P Market Insight) Current Balance Sheet

ANNUAL BALANCE SHEET($ MILLIONS)

PEPSICO INC SIC: 2080 (Beverages)700 Anderson Hill Rd GICS: 30201030 (Soft Drinks)Purchase, NY 10577 S&P Long-Term Issuer Credit Rating: A+Ticker: PEP S&P Short-Term Issuer Credit Rating: Extremely Strong (A1)Fiscal Year: 12

Latest QJun09 Dec08 Dec07 Dec06 Dec05 Dec04

ASSETSCash & Short-Term Investments 2,424.000 2,277.000 2,481.000 2,822.000 4,882.000 3,445.000Net Receivables 5,223.000 4,683.000 4,389.000 3,725.000 3,261.000 2,999.000Inventories 2,952.000 2,522.000 2,290.000 1,926.000 1,693.000 1,541.000Prepaid Expenses NA @CF @CF @CF @CF @CFOther Current Assets 1,031.000 1,324.000 991.000 657.000 618.000 654.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------Total Current Assets 11,630.000 10,806.000 10,151.000 9,130.000 10,454.000 8,639.000

Gross Plant, Property & Equipment 23,369.000 22,552.000 21,896.000 19,058.000 17,145.000 15,930.000Accumulated Depreciation 11,521.000 10,889.000 10,668.000 9,371.000 8,464.000 7,781.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------Net Plant, Property & Equipment 11,848.000 11,663.000 11,228.000 9,687.000 8,681.000 8,149.000 Investments at Equity NA 3,883.000 4,354.000 3,690.000 3,485.000 3,284.000 Other Investments NA 115.000 121.000 149.000 186.000 0.000 Intangibles NA 6,984.000 7,213.000 6,443.000 5,704.000 5,440.000 Deferred Charges NA 1,841.000 1,291.000 625.000 2,977.000 0.000Other Assets 13,572.000 702.000 270.000 206.000 240.000 2,475.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------TOTAL ASSETS 37,050.000 35,994.000 34,628.000 29,930.000 31,727.000 27,987.000

LIABILITIESLong Term Debt Due In One Year 435.000 273.000 526.000 @CF 143.000 160.000Notes Payable NA 96.000 0.000 274.000 2,746.000 894.000Accounts Payable 7,772.000 2,846.000 2,562.000 2,102.000 1,799.000 1,731.000Taxes Payable 412.000 145.000 151.000 90.000 546.000 99.000Accrued Expenses NA 2,843.000 2,894.000 2,587.000 2,581.000 2,377.000Other Current Liabilities 0.000 2,584.000 1,620.000 1,807.000 1,591.000 1,491.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------Total Current Liabilities 8,619.000 8,787.000 7,753.000 6,860.000 9,406.000 6,752.000

Long Term Debt 8,185.000 7,858.000 4,203.000 2,550.000 2,313.000 2,397.000Deferred Taxes 260.000 226.000 646.000 528.000 1,434.000 1,216.000Investment Tax Credit @CF 0.000 0.000 0.000 0.000 0.000Minority Interest 432.000 0.000 0.000 0.000 0.000 0.000Other Liabilities 5,577.000 7,017.000 4,792.000 4,624.000 4,323.000 4,099.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------TOTAL LIABILITIES 23,073.000 23,888.000 17,394.000 14,562.000 17,476.000 14,464.000

EQUITYPreferred Stock - Redeemable @CF (97.000) (91.000) (79.000) (69.000) (49.000)Preferred Stock - Nonredeemable (100.000) 0.000 0.000 0.000 0.000 0.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------Total Preferred Stock (100.000) (97.000) (91.000) (79.000) (69.000) (49.000)

Common Stock 30.000 30.000 30.000 30.000 30.000 30.000Capital Surplus 269.000 351.000 450.000 584.000 614.000 618.000Retained Earnings 27,627.000 25,944.000 27,232.000 22,591.000 20,063.000 17,844.000Less: Treasury Stock 13,849.000 14,122.000 10,387.000 7,758.000 6,387.000 4,920.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------Common Equity 14,077.000 12,203.000 17,325.000 15,447.000 14,320.000 13,572.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------TOTAL EQUITY 13,977.000 12,106.000 17,234.000 15,368.000 14,251.000 13,523.000

------------------ ------------------ ------------------ ------------------ ------------------ --------------TOTAL LIABILITIES & EQUITY 37,050.000 35,994.000 34,628.000 29,930.000 31,727.000 27,987.000