PepsiCo Pre-Earnings: Organic Growth To Be Countered By Negative Currency Impact In Q1

One of the world’s largest food and beverage companies, PepsiCo (NYSE:PEP), is scheduled to announce its Q1 results on April 23, a day after Coca-Cola reports its quarterly performance this year. PepsiCo 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. This quarter could tell the same story, with growth in the domestic market expected to be offset by lower volumes sales and currency depreciation in some of the international markets. Analysts expect a decline in both the top line and earnings per share compared to a year ago period. PepsiCo had earlier forecasted its EPS to grow by 7% this year on a currency neutral basis and excluding one-time items, and negative currency translations to then drag-down this figure by 7 percentage points, meaning no growth in the net earnings per share in 2015. This means that continued volatility in some of the emerging markets could significantly choke growth for PepsiCo this year.

We estimate a $102 price for PepsiCo, which is roughly 5% above the current market price.

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PepsiCo derives slightly more than half of its revenues from the U.S., and with a strong domestic economy, improving customer purchasing power due to lower energy prices, and a jobless rate of only 5.5% at present, the company’s U.S. sales could grow by a healthy rate this quarter. The snacks business, which forms more than half the net sales for PepsiCo, has been the growth driver for the food and beverage giant in the last few years. In particular, the Frito-Lay North America division is expected to grow again this quarter, after a 3% top line growth in 2014, and due to the improving economic conditions in the U.S.  This division is also the most profitable business unit for PepsiCo, with 33.8% EBITDA margins last year, compared to 20.1% margins for the overall company, according to our estimates. This means that higher proportionate profits for this division could also lift the company’s net operating margins.

Speaking of profitability, PepsiCo still lags Coca-Cola in terms of operating margins, achieving only 14.4% margins compared to the latter’s 21.1% operating margins last year. In fact, the 14.4% figure would further fall once the profitable snacks divisions are not considered. There is scope for further margin expansion for PepsiCo, and the company is looking to save another $5 billion in the next five years, as part of its productivity savings plan for 2015-2019, after the completion of its $3 billion savings program between 2012-2014, by optimizing global manufacturing operations and simplifying organization systems to drive efficiency. This could expand PepsiCo’s operating margins, in spite of a flat to slightly negative top line growth.

PepsiCo might be able to squeeze-out higher profits from its ailing carbonated soft drinks (CSD) division in the U.S.  as well. In Q4 last year, organic revenues for PepsiCo Americas Beverages rose 3%, despite CSD volume sales declining 2% year-over-year. 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. 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, which have a higher price per unit. In addition, the company is also driving the premiumization of its soft drinks by raising retail prices of its products, which should aid margin growth this quarter.

What might be a downer this quarter, as aforementioned, is slower growth in international 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.

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, which is the company’s largest international market (contributing ~7% of net sales), had a direct bearing on PepsiCo’s full-year results. Combined sales from Russia, Mexico, and Brazil fell 7% last year, and formed approximately 16% of PepsiCo’s top line. There is scope to grow in emerging economies for the food and beverage giant, but as these economies continue to battle weak economic conditions, lower volume sales due to inflation and negative customer sentiment, and depreciation of local currencies against the U.S. dollar; all these are expected to have a significant bearing on PepsiCo’s financials this quarter.

While sales in the U.S. for both snacks and beverages might grow for PepsiCo in Q1, lower-than-expected demand in some of the key international markets might offset this growth. Negative currency translations are expected to neutralize PepsiCo’s strong core business growth this quarter.

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