Alternate Breakfast Options Eat Into Sales Of PepsiCo's Quaker Foods
PepsiCo ( PEP ) is a leading beverage and snacks manufacturer, with more than half of its sales coming from its booming snacks division. Since category headwinds in sugary drinks pose a threat to PepsiCo's future growth, the company expects two-thirds of its top line growth in 2014 to come from the snacks division. The brands Frito-Lay and Quaker Foods in North America constituted half of the food sales and one-fourth of the overall sales for the company in 2013. But while revenues for Frito-Lay North America have increased 14% in the last five years to over $14 billion in 2013, Quaker Foods has seen a decline of 3% in sales to $2.6 billion during the same period. The shifting trends in the breakfast market have hurt sales of Quaker Foods, which sells hot and cold cereals, snack bars, rice snacks and cookies. Traditional American breakfasts such as oatmeal and sugar cereals are losing customers to quick-service restaurants and dairy products such as yogurt.
We estimate a $87 price for PepsiCo , which is around 10% above the current market price.
Innovation In Hot Cereals Drives Growth For Quaker
The bright spot for Quaker Foods is its constant innovations in the hot cereal segment, in which the company holds an impressive 57% market share. Consumers, especially women who take care of the entire family's nutritional intake form the target demographic for the hot cereal market. The unemployment rate for adult women (ages above 20) fell by 1.3 percent points to 5.9% in January year-on-year. With increasing rates of employment, women are now more pressed for time and are likely to either skip breakfast altogether or consume packaged and other instant foods. PepsiCo has made efforts to remain in tune with the current market trends and provide portable, easy-to-make and precise portions of its hot cereals. In 2012 the company launched its portable Quaker Real Medleys, now PepsiCo's third-best selling hot cereal after regular Quaker Oats and low-sugar Quaker Oats, after registering the highest percent increase in sales in the fiscal year ended May 2013. During this period, sales in the hot cereal segment grew by 4% to $1.2 billion. However, hot cereals represent only 12% of the overall U.S. breakfast cereal market, which saw a growth of less than 1% last year, as sales of cold cereals remained flat.
Cold Cereals Underperform The Breakfast Cereal Market
With some consumers either switching breakfast preferences to healthier and compact foods or skipping breakfast altogether, consumption of cold cereals has declined by 1% each year in the last decade. Cold cereals generated around $9 billion in sales last year, led by Kellogg Co and General Mills, which together accounted for 54% sales in this category. We expect this category to continue to face headwinds in the coming years due to the following factors:
- Instant Foods Take Away Market Share
Breakfast cereals face stiff competition from alternate breakfast choices such as Greek yogurt, drive through fast foods and even milkshakes. Once considered a novelty, yogurt is now the second largest breakfast category behind cold cereals in the U.S., with retail sales of over $7 billion last year. Yogurt constitutes 40% of the breakfast market and continues to outperform the entire category. In addition, cold cereals are also suffering at the hands of quick-service restaurants that provide breakfast. Restaurants such as McDonald's, Wendy's, Subway and now even Taco Bell offer breakfast items that are eating into the market share of cereals. According to Nation's Restaurant News, breakfast is a $42 billion business for the restaurant industry, where the first meal of the day accounts for one in five restaurant visits.
- Unhealthy Perception Of Sugar Cereals
As consumers in the domestic market look to live a healthier lifestyle, the demand for sugary cereals has declined over the years. Consumers now want high fiber and protein content in their breakfast meals, which has hurt sales of the core sweetened cereals category. Growing health awareness could continue to hamper cold cereal sales in the country, where more than one in three people are obese.
- Declining Core Demographic
Children form the core demographic for cold cereals. However, the U.S. fertility rate has declined year-on-year for each of the last five years, hitting an all-time low in 2012. Children below the age of 17 form the smallest segment of the domestic population at present, and their proportion is expected to further decrease in the coming years. A decline in the core customer base also poses a threat to sales of cold cereals.
Quaker Might Strengthen Dairy Portfolio To Drive Future Demand
Volumes for Quaker Foods rose by 3% last year, primarily due to growth in Muller Quaker Dairy (MQD) product volumes launched in 2012. According to Euromonitor, the yogurt and sour milk products market could grow by 10% to $9.3 billion by 2018. As PepsiCo's partnership with the Theo Muller Group is only over a year old, both these companies will aim to compete with established dairy giants such as Danone and Chobani in this budding segment. Danone and Chobani together account for more than half of the domestic yogurt market volumes at present. Although Muller is relatively new to the American market, the company leads the U.K. dairy market with 16% market share and sales of over $500 million in 2012. MQD products might be able to grab some of the market share in the yogurt category and, along with incremental volumes in hot cereals, could offset the decline in Quaker's core cold cereal segment in 2014.