PepsiCo Targets Premium Water Category Amid CSD Woes

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A recent report from Beverage Digest, a trade publication, suggests that PepsiCo ( PEP ) is planning to launch a new premium water brand, OM, by next year. We see this as an attempt by the company to revive its ailing North American beverages business, which has been facing the heat from declining CSD consumption. Although bottled water consumption has been growing strongly as a result of shifting consumer preferences, it is not as profitable a business for beverage companies due to the lack of differentiating factors. Premium water on the other hand allows these companies to earn better margins by adopting a differentiated targeting strategy. We therefore believe a successful launch will help improve operating margins of PepsiCo's bottled water business.

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CSD Woes


The consumption of fizzy drinks has been declining in developed markets over the past few years. The situation in the U.S. is a key example of this trend - per capita consumption of CSDs peaked around 1998 at about 54 gallons a year. Today, the figure stands at around 44 gallons a year. A major reason behind this has been growing consumer awareness about negative health impacts of CSDs. A research paper recently published in the American Journal of Public Health concluded: "Soft drink consumption is significantly linked to overweight, obesity, and diabetes prevalence worldwide." This certainly is bad news for major cola companies Coca-Cola ( KO ) and PepsiCo, both of whom have been hit hard by this trend. PepsiCo posted a 1% decline in organic net revenue in its Americas beverage operations for the second quarter as lower volumes more than offset higher net pricing.

Premium Water

The soda slump has resulted in a surge in bottled water sales in the U.S., which is evident from the fact that the amount of water consumed by an individual on average has grew by ~40% to about 58 gallons per year since 1998. This has primarily been led by strong growth in the consumption of bottled water, which has almost doubled to 21 gallons per year. We expect the trend to continue in the long run as increasing health consciousness and convenience will continue to drive consumers towards bottled water.

However, the issue with bottled water is the lack of substantial differentiating factors, which makes it a commoditized business with high price elasticity of demand. It is therefore not a very profitable business for beverage companies who continue to rely on CSD sales for a bulk of their profits. However, companies can earn more by adopting a differentiated targeting strategy by building brand equity through marketing investments. Differentiated targeting implies offering several brands/products to meet the unique needs of different consumer segments. Coca-Cola's Smartwater , Nestle's Resource , and other popular brands such as Fiji and Evian are betting on the same strategy. According to Beverage Digest, Smartwater volumes have been up ~16% y-o-y during the first half of this year. The overall premium water category has also been doing pretty well, as revenues grew by ~11% last year, which reflects strong demand for these products.

PepsiCo sells bottled water under its Aquafina brand, which holds almost 10% share in the U.S., similar to Coca-Cola's Dasani . However, the company does not offer anything in the premium water category as yet. The introduction of OM premium water brand will allow the company to more effectively compete in the fast-growing bottled water category with better margins.

Both PepsiCo and Coca-Cola have also been increasing their focus on the flavored or fortified water segment as it is offers greater differentiation than regular bottled water. This segment includes products such as PepsiCo's SoBe Lifewater and Coca-Cola's Glaceau Vitaminwater .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: DPS , KO , KRFT , PEP

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