PepsiCo Earnings Review: Snacks And Beverages Make A Good Marriage?

PepsiCo (NYSE:PEP) announced better than expected half-yearly results on July 9, but most of our attention was drawn to the announcement of the combination of the Latin America beverages and snacks businesses. The company has remained committed to deriving synergies between its drinks and foods divisions, while activist investors have pushed the company to spin off the ailing drinks division. Just as with Europe and Asia, Middle East and Africa (AMEA), Latin America will now also be trimmed into one separate operating unit, comprising both drinks and snacks. A segregation of the foods and drinks divisions might be in the cards some time later, but it seems that PepsiCo is heading into the future all intact, for now.

Is this good news?

Well, in taking a look at PepsiCo’s recent results, the answer might just be yes.

We estimate a $98 price for PepsiCo, which is above the current market price.

See Our Complete Analysis For PepsiCo

PepsiCo managed to achieve a 5.1% year-over-year growth in organic revenues in Q2, and raised its full-year core constant currency EPS growth outlook to 8%, from the previously estimated growth rate of 7%. Beverage volume remained flat, while snack volume rose 1% in the quarter. The foods division constitutes roughly half of PepsiCo’s net revenues, but forms 64.3% of the company’s valuation by our estimates. Investors have pushed for a segregation of the company mainly due to the latent potential of the snacks division, which, it is assumed, is being let down by the not-so-prospering drinks division. Snacks continued to outgrow beverages this quarter as well; organic revenues for snacks rose 8%, while organic revenues for beverages rose only 2%. While the world continues to cut back on its sugary soda and juice consumption, savory snacks have consistently seen growth — which is why the foods division is a larger contributor to PepsiCo’s valuation according to our numbers.

However, while the fact that snacks are consistently outperforming beverages remains true, beverages have also shown promising growth in the recent past–not only in developing economies but also developed markets such as the U.S., and the synergies cannot be ignored. For example, according to PepsiCo, a significant part of growing the snacks business includes penetrating all retail outlets that beverages are already in, because the company’s presence in beverage retail outlets is much higher than in snacks. Apart from leveraging PepsiCo’s higher beverage reach to grow snacks too, what the company stands to gain from keeping the two businesses together are synergies.

PepsiCo remains on course to derive productivity savings of $1 billion this year and through 2019, following a similarly aggressive three-year $3 billion program that was concluded last year. Now that the Latin America foods and beverages businesses are being combined, the company aims to cut more additional costs, and derive synergies–especially in a bid to achieve growth in a region which is struggling economically at present. PepsiCo had earlier said how the synergies between the foods and drinks businesses range between $800 million and $1 billion annually, and operating a leaner unit in Latin America might allow the company to more optimally invest the sales generated there for the purpose of future growth.

A boost for the beverages division was growth in North America this quarter, which is important, especially as the U.S. contributes roughly half of the company’s net sales, and slowing drink sales in developed markets has for long plagued sales of beverage manufacturers. Organic volume sales for PepsiCo Americas Beverages rose 1% year-over-year in Q2, and effective pricing increased 4%. The company was able to increase retail sales of its carbonated soft drinks (CSD) across measured channels due to its packaging and pricing initiatives, which somewhat offset the impact of lower volume sales in the quarter.

Although the U.S. CSD market declined for the tenth consecutive year in 2014, the rate of decline fell last year, on increased customer spending on perishable products, amid an improving economic environment in the country, reflecting that there might be some fight left in the CSD category. Why this category is particularly important is because approximately 41% of the industry-wide volumes in the U.S. liquid refreshment beverage market, which stood at 30.88 billion gallons last year, is constituted by CSDs alone, as per our estimates. While Americans continue to fall out of love with sugary sodas, PepsiCo achieved growth in this category through innovation such as the introduction of Mountain Dew Kickstart and DEWshine, and through pricing and packaging wins–by focusing on sales of smaller packs (which have a higher price-per-unit) and raising retail prices. The company is also looking to solve the falling-diet-soda-sales problem by removing aspartame from Diet Pepsi, and replacing it with sucralose, better known as splenda, which has a slightly better customer perception than aspartame.

PepsiCo’s better-than-expected performance in beverages in the U.S. could continue in the near term, bolstered by the introduction of new products, and supported by the ever-so-increasing research and development expenditure by the company. From 2011 to 2014 alone, the food and beverage giant’s investment in R&D has increased almost 40%.

It looks like PepsiCo’s beverage business is also picking up, although slightly, to complement the fast-growing snacks division. However, despite the strong organic growth, the company reported a 6% fall in its top line this quarter, due to a 10% negative effect of currency translations. Considering that markets outside the U.S. form ~50% of PepsiCo’s top line, the continually strengthening U.S. dollar dented the reported earnings. The company’s organic sales in emerging countries grew 11% year-over-year in Q2, however, net revenues fell 13% over 2014 levels on massive negative currency translations. PepsiCo now expects currency translations to drag down full-year net sales and core EPS by 9 and 11 percentage points respectively.

See the links below for more information and analysis:

• PepsiCo mid-year earnings: what to expect?
• Bottled water is a potential growth category that can’t be ignored
• Soda makers wonder: where could growth in U.S. come from?
• Negative currency translations overshadow PepsiCo’s strong organic growth in Q1
• Trefis analysis: PepsiCo Soft Drink Revenues
• Trefis analysis: PepsiCo Frito-Lay North America Revenues

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