PepsiCo Earnings Review: North America Boosts Results While International Growth Slides

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As expected, while North America performed well for PepsiCo (NYSE:PEP), continual volatility in certain crucial emerging markets took away from an otherwise strong performing business in Q4. The food and beverage giant reported its Q4 and full year results on February 11, achieving a solid 5% year-over-rise in organic revenue. [1] However, reported sales declined 5% to $63 billion, hit by a 10 percentage point impact from negative currency translations. Markets outside the U.S. generated 44% of the company’s net revenue in 2015, with Mexico, Russia, Canada, the U.K., and Brazil comprising approximately 20% of the net revenue. The strengthening dollar and slowing demand in crucial economies dented PepsiCo’s results in 2015, with net sales from international markets dropping 14.4%,compared to 2014 levels.

We estimate a $101 price for PepsiCo, which is slightly above the current market price.

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The saving grace, as expected, was the home market, forming 56% of the net sales last year. Both the beverages and drinks segments performed well. The foods division, including the likes of Frito-Lay and Quaker Foods, forms over 63% of PepsiCo’s valuation as per our estimates, fueled by relatively higher sales growth expectations and fatter margins for operating units, such as Frito-Lay North America — the most profitable division for PepsiCo. But last year, beverage growth kept up with that in snacks, especially in North America, headed by non-carbonated beverages. Both the Frito-Lay North America and North America Beverages divisions delivered 3% year-over-year organic revenue growth in 2015, and 7% core constant currency operating profit growth. [2]

 

In fact, with the core segment of carbonated soft drinks (CSD) remaining strained because of sustained health and wellness concerns, growth in beverages in North America can be attributed to PepsiCo’s non-carbonated lineup, including the likes of the sports drink Gatorade, which benefited from higher demand in what was a relatively hotter year last year. CSDs form approximately 62.5% of PepsiCo’s overall North America beverage volume, and declined 2% last year. However, a 6% rise in non-carbonated beverage volume, ensured a 1% growth in overall North America volume. As CSDs continue to bear the brunt of growing health concerns and customer skepticism regarding the usage of artificial sweeteners and/or bitter aftertastes of the diet/low calorie drinks, there has been a continual segment shift from carbonated to certain non-carbonated segments such as sports drinks, ready-to-drink teas, and bottled water, which carry healthier customer perceptions.

However, even the drop in PepsiCo’s CSD volume in North America doesn’t necessarily reflect headwinds. Pricing in CSDs has to be managed carefully, especially as the demand in this category is not particularly sensitive to pricing, as it is to customer perception. PepsiCo has emphasized the sales of smaller bottles and packages, which although they drag down overall volume sales, have higher price per volume. So, while CSD volume sales for PepsiCo have taken a hit, the number of transactions has risen, which essentially means that the transactions are skewed more towards single-serves, which have higher prices. Intelligent price pack architecture, in tandem with innovation, has helped PepsiCo achieve 2% revenue growth in North America.

 

In addition, the extra boost from the positive economic environment helped PepsiCo’s snack and beverage sales in its home market. Gasoline prices have dropped by over 50% in the last 18 months, giving extra cash to customers, which has, in turn, boosted spending in convenience stores. [3] According to PepsiCo, U.S. convenience store sales were up 6% in 2015. Frito-Lay continued its solid performance in 2015, with 2% revenue growth last year. This division alone constitutes 37% of PepsiCo’s valuation by our estimates. Not only is this because of the continual sales growth for Frito-Lay North America, but this is also PepsiCo’s most profitable division, with 29% operating margins in 2015, compared to 15.4% for the overall company (we have excluded the Venezuela charges from the 15.4% operating margins figure). This growth in Frito-Lay North America is fueled by strategic revenue management and pricing gains. A focus on small packs, which are sold for more price per weight, is driving an increase in average revenue per unit and, in turn, profitability.

But despite the solid core growth in North America, what remains an area of concern for PepsiCo is the continual macroeconomic volatility in certain international markets. Revenues from Russia, which used to be the second largest market for PepsiCo behind the U.S. till 2014, fell 36.6% year-over-year last year. 2015 for America-based companies was a year marred by unfavorable foreign exchange, which was an 11 percentage point headwind on the company’s full-year core earnings per share. Russia and Brazil are plunged in recession, and China is also slowing down, which could further dent PepsiCo’s results in 2016. The company remains cautious on the outlook for this year, as the U.S. could also start feeling the heat from subdued demand and weaker economic conditions in the international markets, leading to slower demand in the domestic market, as well. However, the company’s core performance remains solid amid macro headwinds. The company reported core constant currency EPS growth of 10% in 2015, beating its first estimate of 7% growth for the year. Continued innovation and higher marketing and advertising spend should help PepsiCo shine through tough global economic conditions.

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Notes:
  1. PepsiCo 10-k []
  2. PepsiCo earnings transcript []
  3. Coca-Cola, PepsiCo thirst for oil dividend, wsj.com []