PepsiCo Earnings Preview: U.S. Beverages And Russia Sales In Focus

Beverages and snacks giant PepsiCo (NYSE:PEP) is scheduled to announce its third quarter results on October 9. The company’s stock is up over 12% so far this year, more than the growth in chief rival Coca-Cola’s stock and the S&P 500 Index. Despite tepid sales for carbonated beverages, which form over 17% of PepsiCo’s valuation by our estimates, the company’s snacks division has remained strong, growing in both emerging economies and developed markets. Frito-Lay North America is the company’s most profitable division, and is expected to more than offset a possible decline in the beverages business in the region. Analysts expect Q3 revenues to be up 1.2-1.8% year-over-year, following two quarters of relatively flat growth.

In view of the upcoming quarterly results, we analyse factors that could have an impact on PepsiCo’s results.

We estimate a $89.92 price for PepsiCo, which is roughly 4% below the current market price.

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Could Carbonated Beverages Rebound In The Domestic Market?

PepsiCo’s beverages in the Americas constituted nearly one-third of the net sales last year. A continual shift in consumer beverage preferences away from sugary sodas has dragged down PepsiCo’s volumes in North America. In Mexico too, the third largest market for the company after U.S. and Russia, a rise in beverage prices, following the soda tax imposed this January, has deterred carbonated soft drink (CSD) consumption. Latin America volumes rose 3% through the first six months, but Mexico volumes declined as a result of the soda tax, and could continue to fall in Q3.

PepsiCo’s CSDs in North America declined by 1% in the first half of the year. The volume downfall might continue in the third quarter, as consumers switch to other healthier and more natural beverages. But while volumes could remain flat to negative, revenue per unit sale and profitability could improve for the company’s CSD business on increased proportional sales for mini cans. After rising by 34% last year, PepsiCo’s mini can business increased by 24% through June in the U.S. Demand for small-sized offerings has risen, despite the mini cans containing the same calorie count per ounce as the regular 20-ounce bottles, as customers look for less cumulative calorie consumption. According to Euromonitor, while sales in the overall U.S. CSD market remained flat last year, mini can sales rose 3%. ^[1] PepsiCo reintroduced mini cans in 2013, and alongside Coca-Cola and Dr. Pepper Snapple, has pledged to reduce calorie consumption through soft drink offerings by 20% by 2025 in the U.S. These companies plan to achieve this through promotion of low-calorie substitutes and smaller packs, which provide lower cumulative calories in one go. Fighting alongside health activists could help these beverage makers not only to spur positive consumer perception but also expand margins, as smaller packs are relatively more profitable, having higher revenue per unit.

But according to recent convenience-store data, PepsiCo’s domestic CSD volumes could also have had a positive movement this quarter. According to Wells Fargo, PepsiCo’s soft drink volumes grew 1.8% year-over-year in Q3, and average retail pricing also rose 0.4%, buoyed by an overall jump in CSD demand during this period. ^[2] What this means is that PepsiCo’s domestic soft drink business, long considered the weak-link of an otherwise strong portfolio, could be headed for positive growth in terms of both volumes and margins. One of the reasons why PepsiCo’s stock has outperformed broader indices this year is because of rumors of a possible spin-off of the ailing beverages division. However, the company has looked to shrug-off continual activist investor pressure and gain from synergies between the beverages and snacks units. We expect Pepsico’s CSD to grow in North America, contrary to the trend seen so far this year, which could strengthen the company’s resolve to remain intact.

How Would PepsiCo Be Impacted By The Russian Slowdown?

The Russian economy has been struggling lately amid geopolitical issues with Ukraine. The U.S. and the European Union issued sanctions against Russia for supporting separatist rebels in Ukraine, an accusation denied by Russia. Due to the continual weakening of domestic demand and high levels of inflation, and with the Western countries looking to tighten restrictions on Russia’s financial, defense and energy sectors, the International Monetary Fund lowered its outlook on the country’s GDP growth rate to 0.2% this year and 1% in 2015, down from the previously estimated growth rates of 1.3% and 2.3% in 2014 and 2015 respectively. ^[3] But how is this slowdown significant for PepsiCo?

Around 7% of PepsiCo’s revenues this year have come from Russia, the company’s second largest market. In Q1, Russia sales grew by a double-digit percent over the previous year for PepsiCo, representing the highest growth in any of the company’s operating units. However, tepid economic activity and negative consumer sentiment in Russia caught up with the company’s sales in the country in Q2, with both beverage and snack volumes falling by high-single digit percentages.

Apart from slowing volumes in Russia, food inflation and unfavorable currency translations are expected to lower PepsiCo’s revenues in the country in the third quarter. The Russian ruble has depreciated by 14% against the U.S. dollar in the last three months, and this drop in local currency could be a headwind for the company’s net revenues this quarter. ^[4] Inflation rose to 8% in Russia in September, as food prices increased, fueled by the retaliatory ban on many food imports from the U.S. and European Union imposed by the country. ^[5] Higher cost of products is expected to have dissuaded consumers from making purchases, especially related to recreational items such as cold beverages and packaged snack foods. Hurt by lower demand due to higher product prices, and currency headwinds, PepsiCo’s Russia revenues are expected to decline in Q3. A 15% fall in Russia sales would drag-down the company’s net sales by around 1%, by our estimates.

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1. Coke, Pepsi try to fatten bottom line with smaller servings, August 2014, reuters.com [↩]
2. This time, CSDs drive industry sales in C-stores, bevnet.com [↩]
3. IMF cuts Russia’s GDP growth rate forecast, en.itar-tass.com [↩]
4. Ruble-U.S. dollar [↩]
5. Ruble’s fall and food import bans send inflation ever higher, themoscowtimes.com [↩]