PepsiCo Pre-Earnings: Snacks to Drive Sales Growth; Russia and Mexico Volumes Could Fall

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Snacks and beverage behemoth PepsiCo (NYSE:PEP) is scheduled to announce its Q2 results on July 23. Around two-thirds of the top line growth is expected to come from emerging markets and the booming snacks division, as estimated by the company itself earlier this year. This estimate is supported by the trend of contracting carbonated soft drink (CSD) volumes, particularly in the developed North American and European markets, as consumers look to avoid drinks with large amounts of sugar and calories. Possible decline in soda and salty snacks consumption in Russia and Mexico, and growth in demand for beverages and snacks in Brazil, are some of the factors that could impact PepsiCo’s business this quarter.

Margins are expected to slightly grow this quarter fueled by PepsiCo’s productivity savings plan. The company had earlier in the year announced its five-year productivity savings plan for 2015-2019, according to which it plans to save $1 billion each year by optimizing global manufacturing operations and simplifying organization systems to drive efficiency. PepsiCo is on course to draw an incremental $1 billion in savings this year, after saving $900 million in 2013, as part of its savings program for the period of 2012-2014. In Q1, the company achieved operating margins of 14.3%, up 100 basis points over 2013.

We estimate a $86.82 price for PepsiCo, which is roughly 3.5% below the current market price.

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While Russia and Mexico Growth Could Stall, Brazil Volumes to Grow

  • Russia- The U.S. has imposed sanctions against Russia over the Ukraine crises, and European nations such as Germany, France and the U.K. could follow suit in the near future. These sanctions will affect Russia’s economy and could possibly impact food and beverage sales in the country. Russia is PepsiCo’s largest international market, contributing $4.9 billion to the company’s top line last year. While beverage volumes declined in Russia, snacks witnessed a low single-digit-percent growth last year. In the first quarter, Russia was the growth driver for PepsiCo with 10% year-over-year rise in organic sales, led by the snacks division. [1] However, net revenues from the country declined in Q1 over 2013 levels due to unfavorable currency translations. [2] The Russian ruble depreciated nearly 6% against the U.S. dollar from January to May, and could negatively impact PepsiCo’s Russia earnings again this quarter. Geopolitical issues in the country could lead to further economical and operational instabilities, and result in further devaluation of the ruble, dragging down PepsiCo’s revenues from Russia going forward.

  • Mexico- In addition, both food and beverage sales are also expected to fall in Mexico this quarter. The country imposed taxes on certain foods with high amounts of saturated fat, sugar and salt in January. This effectively increased prices of some savory snacks by 8%. On the other hand, a one-peso-per-liter (around 7.6 cents) tax on sugary drinks also raised beverage prices. Mexico is the third largest market for PepsiCo behind the U.S. and Russia, contributing 6.5% to the net revenues last year. With more than half of the country’s population living below the national poverty line, a rise in junk food and beverage prices is expected to dissuade price-sensitive customers from consumption. [3] After seeing growth in previous quarters, the soda and junk food taxes lowered PepsiCo’s food and beverage volumes in Mexico in Q1, and this trend could continue in this quarter as well. PepsiCo’s organic revenue from the foods business in Mexico declined by a low-single-digit percent in the first quarter. On the other hand, beverage volumes also fell in the country to cause a 1% decline in the company’s overall Latin America volumes through March.
  • Brazil- Although Coca-Cola was the official sponsor for the recently completed FIFA World Cup held in Brazil, PepsiCo also launched its worldwide ad campaign centred on the World Cup, and strengthened its marketing initiatives. The football World Cup, being a global event, attracted large crowds from all over the world, also increasing demand for junk food and cold beverages in the country. Brazil is PepsiCo’s fifth largest international market after Russia, Mexico, Canada and U.K., contributing nearly 3% to the top line in 2013. In the first quarter as well, amid volume decline in Mexico, Latin America sales for the company were boosted by mid-single-digit increases in both food and beverage volumes in Brazil. Increased marketing and promotional activities could have attracted more consumers during the World Cup, especially tourists, and could boost PepsiCo’s Brazil sales this quarter.

Soft Drinks to Fall in the U.S., Salty Snacks Could Remain Strong

  • Beverages in the U.S.- Sodas continue to face an uphill battle in the U.S. against growing health concerns among consumers regarding large amounts of sugar and calories in such drinks. Diet CSDs, which offer a low/no calorie alternative, have fared even worse in the last couple of years in the domestic market, as consumers question the safety of artificial sweeteners. Soda sales fell by 3.2% year-over-year to less than 13 billion gallons last year, capping-off the ninth consecutive year of decline in sales. [4] Dollar sales of CSDs further fell by almost 3% in the twelve weeks ended April 12 in measured channels. [5] Downward pressure on CSDs worsened in the four week period ended April 12 as volumes fell by 5.7%. But the steepest decline was recorded in diets, with retail sales contracting 9.5% year-over-year. PepsiCo’s soft drink volumes decreased 1% in Q1, similar to the decline seen by its chief rival Coca-Cola during the period. Contraction of soda volumes is expected to continue this quarter.

  • Snack Foods in the U.S.- The Frito-Lay North America division alone constitutes 35% of PepsiCo’s valuation by our estimates, compared to only 17% constituted by the entire CSD portfolio. Although Frito-Lay North America generated 21% of the net sales in 2013, it is PepsiCo’s most profitable division, and its revenue-growth is expected to outpace that of the beverage segments this quarter. While CSDs continue to bear the brunt of widespread health and wellness concerns, the snack food market has managed to grow at a steady pace. The domestic snack food market worth $35 billion grew at a CAGR of 3.8% between 2009-2013. [6] [7] PepsiCo, which holds around 28.7% volume share in the U.S. CSD market, second behind Coca-Cola’s 42.4% share, dominates the savory snacks market in the country with a 36.6% market share. The next biggest manufacturers in this sector are Kellogg’s and Mondelez with much smaller 7% and 5.6% share respectively. According to a research by Business Wire, over 90% of households in the U.S. reported salty snack consumption in the past month, with two-thirds of the households routinely consuming at least three varieties of salty snacks. [8] Americans have a large snacking habit, which is expected to continue to bolster growth in the salty snacks market this quarter.

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Notes:
  1. PepsiCo earnings transcript“ []
  2. PepsiCo 10-q []
  3. Poverty headcount ratio at national poverty line“, worldbank.com []
  4. The U.S. liquid refreshment beverage market remained flat in 2013“, March 2014, beveragemarketing.com []
  5. CSD declines worsen, April 2014, cspnet.com []
  6. The diet soda business is in freefall, finance.yahoo.com []
  7. Snack food production in the U.S.“, April 2014, ibisworld.com []
  8. Salty snacks in the U.S., businesswire.com []