PepsiCo Shows Strong Pricing But Offset By One-Offs And Currency Headwinds

PepsiCo (NYSE:PEP) announced its Q3 FY2012 earnings on October 17. The company saw its revenues hurt by a strong US dollar and refranchising deals in China and Mexico, which knocked off 10 percentage points from the top-line. Total revenue declined 5% to $16.7 billion. On the bright side, revenues grew 5% on an organic basis reflecting 1 percentage point of volume growth and 4 percentage points of pricing. Net income stood at $1.9 billion or $1.21 a share, down 5% from last year. Management reaffirmed the full year guidance of a 5% decline in EPS, which stood at $4.40 in 2011.

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Reported snacks volume grew 6% (and 3% on an organic basis) while beverage volume rose 3% (1% on organic basis). Global beverage volumes were helped by a strong Chinese performance but partially offset by tepid European and American volumes. Snack volumes were boosted by a strong Russian performance and the acquisition of Brazil’s Grupo Mabel in the last quarter of 2011. Russia, in particular, has been one of the better performing regions for the PepsiCo and its presence in the country was further bolstered by the acquisition of the dairy giant Wimm-Bill-Dann in December 2010.

Margins to Improve

This year is a transitional year for PepsiCo as it plans to lay off 8,700 employees and step up marketing efforts to reinvigorate flagging soft drink sales in North America. PepsiCo also spent an additional $600 million on marketing in 2012. So far, the company has introduced Pepsi Next, a mid-calorie variant of its flagship drink Pepsi, and launched its first ever global campaign called ‘Live for Now’.

PepsiCo benefited from strong pricing as gross margins jumped to 53.0% from 51.9% a year earlier. However, operating margins remained flat as stronger pricing was offset by higher expenses related to marketing and multi-year productivity plan (called the ‘Productivity Plan’). As part of its ‘Productivity Plan’, PepsiCo incurred $103 million this quarter and has incurred a total of $193 million year-to-date. Furthermore, the company expects to incur an additional $205 million of expenses for the remainder of the year, but only $129 million from 2013 through 2015. Thus, expect the full year margins to decline in 2012. From 2013 onward, we expect margins to improve as the expenses related to the productivity plan decline.

We have a price estimate of $78 for PepsiCo, which is about 10% higher than the current market price.

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