PepsiCo Earnings Review: Both Beverages and Snacks Boost Organic Revenues in Q2

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Snacks and beverages manufacturer PepsiCo (NYSE:PEP) reported 0.5% growth in net revenues in Q2, with organic revenues rising 3.6%, on July 23. As expected, the snacks business, which constitutes more than half the net sales for PepsiCo, drove top line growth in the quarter. Organic revenue grew 5% for the snacks division, which forms over 60% of the company’s valuation by our estimates, while beverage sales rose 2% globally during this period. [1] Non-sparkling beverages such as sports drinks, ready-to-drink (RTD) teas and coffee continued to rise owing to healthier consumer perception and low current penetration levels. On the other hand, sparkling volumes declined in North America, reflecting continued headwinds in the domestic carbonated soft drinks (CSD) category, which declined for the ninth consecutive year in 2013. PepsiCo had earlier in the year expected around two-thirds of its top line growth this year to come from emerging countries. As expected, organic sales in developing and emerging nations increased 8% in Q2, however, unfavorable currency translations and the Vietnam refranchising dragged down net revenue growth from these countries to negative 1%. For the full year, PepsiCo expects organic revenues to increase by a mid-single-digit percent over 2013 levels, while foreign currency translation to have a negative 3% impact on the net sales.

We estimate a $86.82 price for PepsiCo, which is roughly 5% below the current market price. However, we are currently in the process of incorporating the latest quarterly results into our forecasts.

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North America Sparkling Volumes Continue to Fall

While PepsiCo’s still beverage portfolio grew 1% in North America this quarter, the sparkling unit witnessed 2% decline in volumes. This decline is in line with the trend of contracting soda volumes in the domestic market as consumers look to avoid high-sugar and calorie fueled CSDs. 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. [2] Dollar sales of CSDs further fell by almost 3% in the twelve weeks ended April 12 in measured channels. [3] The bright spot for PepsiCo’s sparkling portfolio was the mid-single-digit growth in the drink Mountain Dew’s volumes in measured retail channels this quarter. [4] PepsiCo’s soft drink volumes decreased 1% in North America in Q1, similar to the decline seen by its chief rival Coca-Cola during the period. However, Coca-Cola’s sparkling volumes remained flat in North America in Q2, while PepsiCo’s volumes declined 2% in the region. This means that the gap between both the beverage giants further widened in the domestic CSD market this quarter. Coca-Cola leads the U.S. soft drinks market with 42.4% share, while PepsiCo commands 28.7% value share at present, by our estimates.

Snacks Deliver Solid Growth Amid Rising Health Concerns

PepsiCo’s Frito-Lay North America (FLNA) division saw 2% revenue growth this quarter. This division alone constitutes 35% of PepsiCo’s valuation by our estimates, compared to only 17% constituted by the company’s entire CSD portfolio. Although Frito-Lay North America generated 21% of the net sales in 2013, this division is highly valued as it is PepsiCo’s most profitable division, and its revenue-growth is also expected to continue to outpace that of the beverage segments going forward. Core constant currency operating profit for FLNA also rose by 5% in Q2, fueled by sales growth and net pricing gains, and also due to the productivity savings plan initiated by the company. PepsiCo 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. The company 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. Core operating margins expanded by 65 basis points in the second quarter, excluding the gain from the Vietnam refranchising from Q2 2013 results.

Although PepsiCo reported headwinds in the domestic packaged foods business this quarter, the company’s food lineup continued to post growth, mainly due to an established strong brand appeal and loyal consumer base. The U.S. snack food market worth $35 billion grew at a CAGR of 3.8% between 2009-2013. [5] [6] PepsiCo 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% shares respectively. The salty snack market is worth $28.2 billion presently, with potato chips and tortilla chips forming 20% and 13% of the sales respectively. [7] Frito-Lay commands the lead in salty snacks, with market shares of 60% in 72.4% respectively in potato chips and tortilla chips. [8] ((Leading vendors of tortilla chips, statista.com)) Sales for the brands Lay’s, Doritos and Cheetos grew again this quarter by low to high-single-digit percentages.

Latin America Snack Food Volumes Fall While Beverages Grow

As expected, Mexico food sales for PepsiCo fell this quarter, primarily impacted by the tax imposed by the government on certain foods with high amounts of saturated fat, sugar and salt in January. This effectively increased prices of some savory snacks by 8%. With more than half of the country’s population living below the national poverty line, a rise in junk food prices dissuaded price-sensitive customers from consumption, and resulted in PepsiCo’s organic food revenues decreasing by a low-single-digit percent in Q2. [9] However, the company’s beverage volumes in the country grew in the quarter, with overall Latin America drink unit sales rising 3% year-over-year. PepsiCo’s beverages grew in Mexico despite the one-peso-per-liter (~8 cents) soda tax on sugary drinks enacted in January, which raised prices of beverages. In contrast, Coca-Cola’s Mexico volumes fell 3% this quarter. Mexico is the third largest market for PepsiCo behind the U.S. and Russia, contributing 6.5% to the net revenues last year. With growth in the Mexico drinks business despite the impact of the soda tax, PepsiCo could have further improved its market share in the country.

On the other hand, PepsiCo’s food and beverage sales climbed in Brazil this quarter, despite continued economic instability in the country this year. 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.

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