The Quaker Oats Company

The Quaker Oats Company ("Quaker") is the leader in sports drinks globally, the fourth largest global cereal company, and it also has a sizeable convenience food business. Operations exhibit the following strengths: (1) The brand portfolio is strong, if not overly deep, with over 80% of sales in categories where it holds leading market shares. Quaker has had good success with recent product introductions. (2) Quaker has divested a number of its less profitable divisions to focus on its core areas, causing sales to fall to about $5.0 billion, even as EBITDA levels have improved to the $800-$900 million range. Profitability is strong compared to peers and trending up, with EBITDA margin in the 17%-19% range and ROC above 30%. (3) Diversification by product category is strong and lends stability to results. The U.S. food area is the largest division with close to 60% of sales and slightly larger portion of operating profits, with Gatorade contributing the remainder. (4) Recent restructuring charges have improved productivity, including the F2000 charge that is estimated to save about $70 million by 2002. (5) The balance sheet should remain above average with good coverage ratios as cash flow is strong (now in the $600 million range) and should fund internal needs over the near future.

Despite its strengths, numerous challenges exist: (1) Industry competition will remain intense from both branded and private label products. Aside from Gatorade, snacks and hot cereal, many of Quaker's divisions have recently had stagnant results. (2) A globally consolidating food retail industry could further pressure margins. (3) Geographic diversification is weaker than most peers, with over 80% of sales and all operating profits coming from North America. (4) Many products are in mature categories and markets with limited growth potential. (5) Consolidation activity in the consumer product industries may increase longer-term competitive levels.

Sales and volumes both rose about 7% through the nine months ended September 30, 2000, with strong results from Gatorade and snacks offsetting weaker cereal volumes. While the restructurings have helped lower costs, especially within U.S. foods, EBITDA growth was good but restrained as a large portion of the savings have been directed to higher advertising and new product costs for Gatorade. Quaker should post reasonable near-term sales and volume improvement as the core divisions should continue to yield relatively stable results, augmented by organic growth from innovation and Gatorade's expansion. Profitability is likely to improve further as the restructuring savings are realized.

PepsiCo Inc.


Globally, PepsiCo Inc. ("PepsiCo") is the largest snack food company, the second largest carbonated soft drink player and #1 in premium orange juice. Operations exhibit the following strengths: (1) After restructuring its operations in recent years, PepsiCo holds a strong portfolio of branded products with a large portion of sales in categories where it holds the leading market position. (2) Sales and EBITDA levels are high, in the $20.0 billion and $4.0 billion range, respectively. Profitability is comparable to peers despite being previously stagnant for a number of years. (3) Geographic and category diversification is good and lends stability to results. The U.S. is the largest market with 65% of sales but a higher percentage of operating profits. Frito-Lay is approximately 60% of sales and operating profits, with soft drinks at 25% and 31% respectively. (4) PepsiCo has strong category management skills and good innovation capabilities that, along with cost reduction efforts from recent restructurings, should help growth and profitability. (5) The bottling operation's IPO benefited margins, lowered capex and improved the balance sheet. Cash flow is stable and above-average (near $3.3 billion in 1999) and should cover internal needs over the near future.

The following challenges exist going forward: (1) Although now likely more disciplined, competition will remain intense from both branded and private label products. Until recently, PepsiCo has had difficulty in raising its global beverage market share, and recent price hikes have limited volume growth. (2) Many products are in mature categories and markets with limited growth potential, with a large portion of future growth expected through cost savings and international expansion. (3) A globally consolidating food retailer industry could further pressure margins as its collective buying power improves. (4) Anticipated share repurchases of approximately $1 billion per year and potential acquisitions, including the recently renewed $13.7 billion bid for The Quaker Oats Company, are expected to utilize most free cash flow and restrain debt reduction efforts, in addition to presenting significant integration risks. (5) Although improving, overall returns from the international businesses remain low. (6) Further consolidation activity in the branded products industry is expected and could raise competitive levels over the longer term.

Results for the first nine months of 2000 (end September 2) were good as sales rose 12% (excluding spun-off bottling interests), driven by higher volumes and pricing across all divisions. This aided EBITDA to rise over 10% to $2.29 billion despite higher advertising costs. While strong volume growth is not anticipated, PepsiCo's results should be steady and profitability rise over the longer term, aided by the expansion of Frito-Lay internationally and beverage's high margin convenience channel and per capita consumption.

The Coca-Cola Company

The Coca-Cola Company ("Coke") is the world's largest carbonated soda and beverage company, with operations reflecting the following positive factors: (1) Coke markets a strong branded beverage portfolio, with high recognition and substantial market shares (about 44% in the U.S. and the leading global position). (2) While growing relatively slowly, sales and EBITDA are high in the $20 billion and $5.5 billion range respectively. Profitability is comparable to peers, despite falling in 1999 with weaker results. (3) Geographic diversification is strong and helps lend stability to results, with about 60% of sales and 70% of profits derived internationally. (4) Strong category management skills and innovation capabilities, along with cost savings from the recent large restructuring efforts, should benefit Coke's growth and profitability. (5) Coke has a strong worldwide local market presence through its minority equity ownership stakes in many of its larger bottlers. (6) Operational cash flow is above-average, in the $3.8-4.0 billion range annually, and rising steadily. This should easily fund internal needs and allow the balance sheet to remain reasonable over the near term.

Despite its strengths, several challenges to Coke's future growth exist, including: (1) With new senior management, Coke has significantly altered its target of achieving 50% U.S. market share. The marketing strategy has also been changed from the prior head office directed price discounting to a more localized, brand-building marketing campaign aided by the bottlers. Concurrently, retail prices have been raised to improve profitability in future consumption channels. While the changes should benefit profitability, these will be difficult to implement successfully and have restrained short-term growth. (2) Although now likely more disciplined, competition will remain intense from both branded and private label products. (3) Many products are in mature categories and markets with limited growth potential. (4) The consolidation of global food retailers (constituting the majority of U.S. volumes) is likely to continue to pressure margins. (5) While currently restrained, share repurchases have been significant in the past and are expected to resume.

Results for the nine-months ended September 30, 2000, were reasonable as global revenues and volumes both rose near 5%. The higher retail prices kept current volumes flat in North America but were compensated by stronger international results. Coke's traditional products have seen slower growth, with better gains in the smaller non-carbonated portfolio. Results should continue to be strong and relatively stable with the powerful brand portfolio, with moderate volume growth expected for the coming year.