PepsiCo (NYSE:PEP) is scheduled to report its second quarter earnings on July 24. We expect the results to receive a boost from the company’s growing snacks business in developed markets where PepsiCo is leveraging the growing popularity of nutritional snacks. On the other hand, the declining consumption of carbonated soft drinks (CSDs) in these markets will negatively impact PepsiCo’s earnings. Coca-Cola, its prime competitor in the beverage industry, is also gaining ground in the fast growing still beverage categories.
Moreover, currency headwinds from strengthening U.S. dollar and structural changes implemented in China and Vietnam last year will also dent the company’s second quarter earnings. However, PepsiCo might be able to offset some of that through savings from its ongoing productivity program targeting $900 million savings for the year.
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Snacks To Drive Growth
PepsiCo’s snacks division, which operates through brands such as Lay’s, Quaker and Doritos, has been performing well in recent years, maintaining and growing its market share in both developed and emerging markets.
In developed markets, the company has been leveraging a shift towards healthier snacks, relying largely on new, gluten-free and low fat products to drive sales. Recently, Muller Quaker Dairy, a joint venture (JV) between PepsiCo and Theo Muller Group of Germany, announced the opening of a new manufacturing facility in Batavia, New York. The companies aim to expand the distribution of Muller yogurt servings from select regional markets to cover nationwide stores, increasing their share in one of the fastest growing categories in the U.S. food and beverage industry. (See: PepsiCo Expands Yogurt Production To Target Healthier Eating Trends)
PepsiCo is also focused on diversifying its pricing mix in developed economies with new products being launched in both the premium and low-priced segments. This is helping the company access a broader range of consumers. The company’s attempts at experimenting with local tastes and preferences have also helped it gain ground in emerging markets despite stiff competition from local players.
The company’s strong performance in the snacks division is highlighted by the top line growth of Pepsi Americas Foods, which includes snacks sales in North and Latin America. During the first quarter, sales from the division that contributed ~40% to the company’s consolidated net revenues and ~60% to its total operating income, grew 5% y-o-y. We expect the snacks division to be the primary growth driver for the company during the second quarter. 
Beverages To Drag
Although soda consumption has been declining in the U.S. over the past several years, beverage companies had been able to compensate for that through pricing measures until 2012. According to the Wall Street Journal, data collected by the SymphonyIRI Group suggests that carbonated soft drink (CSD) sales declined by 0.6% in the U.S. in 2012 as lower volumes ultimately offset the benefit of price increases.  The trend was also visible in PepsiCo’s first quarter earnings when a mid-single digit decline in CSD volumes drove 1% decline in net revenues from its Americas beverage division.
Moreover, Coca-Cola has also been gaining ground in some of the fast growing still beverage categories. PepsiCo’s non-carbonated beverages volume, which makes up ~65% of the total volume, declined 1% during the first quarter while Coca-Cola reported mid single digit growth in the segment for the first six months. If Coca-Cola’s second quarter earnings are any indication, PepsiCo’s Americas beverage division is expected to remain under pressure in both CSD as well as still categories. Coca-Cola reported a sharp 4% decline in CSD volumes in North America and 6% growth in still beverages worldwide posting volume share gains in almost all categories. (See: Coca-Cola Loses Its Fizz On Bad Weather, Slower Emerging Markets Growth)
Currency headwinds from the strengthening U.S. dollar, refranchising its bottling operations in China and structural changes implemented in Vietnam last year are also expected to put PepsiCo’s financials under pressure. However, the company might be able to offset some of that through its ongoing productivity program targeting $900 million savings for the year.
We will soon be updating our $77 price for PepsiCo based on the second quarter earnings announcement.Notes: