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How PepsiCo Inc Has Found Success in Innovation and the Defiance of Activist Investors

After years of playing catch up with industry leader Coca-Cola (NYSE: KO), PepsiCo (NYSE: PEP) has successfully closed the gap with its archrival and grown its valuation over the last three years by developing novel variations of its best-selling brands. The company has also enjoyed success with its beverages and snacks strategy after resisting the drastic changes proposed by vocal shareholders.

In this segment from Industry Focus: Consumer Goods, Motley Fool analysts Asit Sharma and Vincent Shen take a look at how the company has made progress by staying true to the management team's vision. 

A full transcript follows the video. 

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This podcast was recorded on July 19, 2016. 

Vincent Shen: Going to the number two here in the industry which is half snack business, half drink business but obviously drinks still very significant. PepsiCo, what do you think?  

Asit Sharma: Sure. PepsiCo is doing a great job right now transitioning as well. They're a $63 billion company. They have the snacks business, so they're actually larger than Coke. Some of the things that they're drawing the lessons are from Coke's playbook that they are also looking for productivity savings. They're shooting for a billion dollars this year in cost savings alone. It looks like they'll hit that.  

They're using higher marketing spends to prop up those declining soda volumes. Of course, it's a beverage and a snack company. It's got that diversification. Frito-Lay North America itself, which is a division of PepsiCo, is a $14.8 billion business. It's a $15 billion company on its own. That's provided some support against the soft drink decline.  

Pepsi also employs a strategy of relentless innovation. On their last conference call, Indra Nooyi, their CEO, mentioned that about 9% of revenue now, that's $5 billion, comes from new products. I'll give you an example of this innovation. The company is coming out with a new type of Mountain Dew called Mountain Dew Black Label. It's sort of a craft version of Mountain Dew if you can imagine such a thing. It features real sugar and herbal bitters in its composition.  

They're marketing this to a younger crowd, millennials obviously, and the CEO pointed out -- Indra Nooyi pointed out -- that this is when Mountain Dew customers want to have their drink with a touch of class. They're really innovative in the sense that they know where the millennial customer is going and for them, it's less about these bolt-on acquisitions that Coke does and more about developing new varieties in-house.  

Shen: Okay. Mountain Dew Black Label. I have to say I am really surprised to hear someone put the words "Mountain Dew" and "class" in the same sentence, but I haven't seen that yet. I'm actually really curious to try it. Some of the listeners might laugh at me, but I still actually enjoy a Mountain Dew every now and then. It's probably one of the few sodas I actually still seek out on occasion. This actually has me really intrigued now.  

Sharma: Sure. Well, I'll tell you what. Maybe they could entice you with another strategy they're using which is the cross marketing of their products. Pepsi, they're doing a great job in convenience stores which is a growing channel for soft drinks and snack beverages of putting the displays together. You'll see Doritos cross market with the Mountain Dew. So, Vince, you can grab some Doritos while you're at it once you pick up your Black Label Mountain Dew.

This is a strategy that actually was -- they had an active investor, Nelson Peltz who didn't like this idea at all several years ago. He actually wanted to split the company up. He wanted PepsiCo to sell its snack business, it's Frito-Lay and also Quaker Oats to Mondelez, which is the company which used to be Kraft in this merry-go-round of brand names, but Indra Nooyi and her executive team resisted. This was about three years ago in 2013.  

What they did was they insisted that "if we market our products together, snacks and beverages, we'll be stronger". In the resisting, they actually did grow revenues at a faster rate. Nelson Peltz said: "Hey, if you don't break this company up, you're always going to be a number two to Coke. You'll always have lower growth rate, and you'll always be valued by investors as not quite as much as Coke is."  

Low and behold three years later, by sticking with this better together that is snacks and beverages strategy, PepsiCo now commands a premium valuation multiple to Coke. It's just a bit over Coke's, but they've caught up. That's really interesting to me to see.  

Shen: Yeah. I wasn't aware of some of the history with the active investor. When you brought that up yesterday I thought that was just some really interesting background. In this case I think overall Indra Nooyi generally has a strong reputation with the shareholders and investors and obviously holding out in this case has definitely helped the company.

Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends PepsiCo. The Motley Fool recommends Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.