PepsiCo Earnings Review: Negative Currency Translations Offset Strong Organic Growth In 2014

+6.13%
Upside
175
Market
186
Trefis
PEP: PepsiCo logo
PEP
PepsiCo

PepsiCo (NYSE:PEP) reported robust organic growth in 2014, especially in the U.S., but the negative impact of currency translation dragged down top line growth for the company. Net revenues remained flat for the food and beverage giant, even as organic revenues grew 4% for the year. [1] At the beginning of 2014, PepsiCo stated how it expected two-thirds of its top line growth for the year to come from snacks (division-wise) and emerging markets (geography wise). However, increased volatility in some of the key emerging economies, especially Russia, had a direct bearing on PepsiCo’s full-year results. Negative currency translations prevented PepsiCo from achieving growth in reported sales, but the results also highlighted how the company’s core business growth remained strong. The snacks division, Frito-Lay North America, continued to drive sales and bottom-line expansion for the company, growing net revenues by 3% year-over-year on a 2% rise in volume sales. This division is the most profitable for PepsiCo, and contributed approximately 22% to the net sales last year.  Increasing proportionate sales for the snacks division, particularly Frito-Lay North America, could see the company’s operating margins expand further this year.

PepsiCo was in the news a lot last year as a section of investors continued to push for segregation of the company into two separate businesses, in effect removing the ailing beverages unit, which was considered to be holding-off the otherwise thriving snacks unit from unlocking its true potential. The company managed to increase its beverage volume by 1% in 2014, similar to the 1% growth seen by snacks, and also achieved its targeted productivity cash savings, possibly warding-off some of the activist investor pressure. [2] In particular, it was a great quarter for PepsiCo Americas Beverages (PAB), which saw rises across volume sales, revenues, and operating profit.

In this article, we will discuss the rise in sales for the PepsiCo Americas Beverages division and the impact of foreign currency depreciation on the company’s financials in the past year.

Relevant Articles
  1. What’s Next For Pepsi Stock After A Mixed Q4 And 6% Fall Last Year?
  2. After A 25% Fall In 2023 Is Campbell A Better Pick Than PepsiCo Stock?
  3. What’s Next For PepsiCo Stock After A Q3 Beat?
  4. What To Expect From PepsiCo’s Q3?
  5. Which Is A Better Pick – PepsiCo Stock Or Amgen?
  6. Is PepsiCo Stock A Better Pick Over Cisco?

We estimate a $91 price for PepsiCo, which is roughly 8% below the current market price. However, we are in the process of incorporating the quarterly results into our forecasts and revising our current price estimate.

See Our Complete Analysis For PepsiCo

Currency Neutral Operating Profit Rises

Even as carbonated soft drink (CSD) volume sales for PepsiCo fell 2% year-over-year in North America in Q4, organic revenues for PAB rose 3%. This was mainly on the back of a 2.5 percentage point impact of effective net pricing, and also a 3% rise in Latin America volume sales. CSDs form 17% of the company’s valuation, and as customers continue to move away from these sugar and calorie-fueled drinks, the U.S. CSD market declined for the tenth consecutive year in 2014. Just for reference, over 50% of PepsiCo’s revenues last year came from the U.S., but this figure also includes the food revenues.

What helped PepsiCo increase its revenues was a successful pricing strategy, also aided by a pick-up in the general economic environment in the domestic market. The company has been stressing the sales of smaller packages, in a bid to reduce overall calorie consumption in the U.S. This is because even though the 12-ounce bottles and mini cans contain the same calories per unit volume as the regular 20-ounce and 24-ounce bottles, the smaller packs have lesser cumulative sugar amounts, persuading the calorie-conscious consumer to purchase them.  Fighting alongside health activists has also benefited PepsiCo and its top line growth, as the smaller packs have a higher price per unit. In addition, the company was also able to increase retail prices of its soft drinks due to the improving economic conditions in the U.S., with falling oil prices and historically low unemployment rates, which boosted customer purchasing power in the country. According to Citi Research, the consumer-price index for nonalcoholic beverages grew in each of the months through September-December, after remaining flat for two years. Despite tepid volume sales, CSD sales in the U.S. increased 1.2% year-over-year in the twelve weeks ended December 28, mainly on a 3.8% rise in prices during the same period. ((Coke, Pepsi feeling drained overseas, wsj.com))

Fueled by a positive price mix, PAB’s core currency neutral operating profit rose 4% for the full-year. An increase in profitability was also buoyed by the successful implementation of PepsiCo’s productivity savings plan. Investors in favor of segregating the company into separate beverage and snacks businesses argue how the cost-cutting at each company, following the split, would more than make up for their current synergies. But the food and beverage giant remains committed to deriving synergies, and completed its $3 billion productivity savings program for the period of 2012-2014. Now the company looks to save another $5 billion in the next five years, as part of its productivity savings plan for 2015-2019, by optimizing global manufacturing operations and simplifying organization systems to drive efficiency. This is expected to drive further growth in PepsiCo’s profitability in the future.

Currency Headwinds Offset Organic Growth In Emerging Markets

Over 22% of PepsiCo’s 2014 revenues came from Russia, Mexico, Canada, the U.K., and Brazil. Despite macroeconomic and political volatility in some of the key emerging markets, organic sales in emerging countries grew 9% year-over-year last year. However, this strong growth didn’t translate into top line growth for PepsiCo, as net revenues from developing markets fell 1% over 2013 levels on massive negative currency translations. In particular, depreciation of the Russian ruble and Venezuelan bolivar were detrimental to the company’s realized sales growth.

How currency depreciation in some markets marred PepsiCo’s otherwise strong core growth can be explained by taking the example of the Latin America Foods (LAF) division. Despite a 10% increase in organic revenues, led by Venezuela, Brazil, and Argentina, reported net revenues grew only 1%, reflecting an 8-percentage-point unfavorable impact of foreign exchange translation. Continual volatility in some of the key emerging markets is why PepsiCo expects currency to bring down full-year net sales growth by 7 percentage points in 2015 as well. This means that the company might not achieve positive sales growth again this year, despite achieving strong organic growth.

In particular, increased geo-political volatility in Russia is expected to weigh on PepsiCo’s financials going forward. Russia is the company’s second largest market, contributing roughly 7% to the net sales. The country’s economy has been struggling amid geopolitical issues with Ukraine, sanctions from western countries, and collapsing oil prices. Economic weakness in the region, with the ruble continuing to depreciate against the U.S. dollar, is expected to negatively impact PepsiCo’s business. However, PepsiCo might just have these potential problems covered. The company produces most of the products sold in Russia in the country itself, sourcing a lot of the required raw materials from local suppliers. A high proportion of local produce utilization could somewhat shield PepsiCo from the import bans and depreciation of the ruble. In addition, the company is mainly present in the dairy and juice space in Russia, and as these categories tend to maintain high and stable consumer demand in the country, rising product prices due to inflation fueled top-line growth in 2014, and could continue to do so. Having said this, PepsiCo’s sales in Russia could be dragged down by negative currency translations, owing to the import of some food and beverage products.

2015 could tell the same story of strong organic growth brought down by negative currency translations for PepsiCo. However, the company will look to improving volume sales, particularly in the U.S. beverage segment, aided by improving economic conditions in the country, to boost sales this year.

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. PepsiCo 8-k []
  2. PepsiCo earnings transcript []