PepsiCo Earnings Preview: What We Are Watching

PepsiCo (NYSE:PEP) is scheduled to announce its Q2 earnings on July 25. The management has reaffirmed a 5% lower EPS for 2012, which is expected to be a transitional year for the company as it plans to lay off 8,700 employees and step up marketing to reinvigorate the flagging soft drink sales. In 2011, PepsiCo derived 52% of its revenues from food products and the remainder from beverages. Due to its diverse product portfolio, the company competes against the likes of Coca-Cola Co (NYSE:KO), Kraft Foods (NYSE:KFT), Nestle S.A. and many other food and beverage companies.

We maintain a price estimate of $69 for PepsiCo, which is in line with the current market price.

Soft Drink Revival?

Earlier in the year, the company launched Pepsi Next, a mid-calorie variant of its flagship drink Pepsi, which has generally received positive customer reviews. Its market share stood at 1%, as per recent reports. PepsiCo’s soft drink volumes in the U.S. have declined for the past few years, but with the help of Pepsi Next and increased marketing, we could witness a slight positive/flat growth for the year. Volumes for Gatorade, another key division of the company, grew 9% in 2011. ^[1] PepsiCo has expanded the Gatorade to G Series which now contains protein bars and shakes to tap in the $20 billion sports nutrition market.

In the snacks category, Frito-Lay is the No. 1 potato chip brand globally. Earlier in the year, PepsiCo announced that the annual retail sales of its global “Banner Sun” potato chip portfolio within the Frito-Lay division surpassed $10 billion. In March, Frito-Lay also extended its SunChip brand by introducing 6 Grain Medley in 2 flavors: Parmesan & Herb and Creamy Roasted Garlic. We expect Frito-Lay’s market share to rise gradually from 39.1% in 2011 to 39.7% by the end of Trefis forecast period. The company’s international market share in 2011 was boosted by the acquisition of Grupo Mabel, the second largest maker of cookies in Latin America, in a deal valued at $520 million.

Margins May Get Hurt

Besides Pepsi Next, most of PepsiCo’s new forays are into food with the most recent being the joint venture with Germany’s Theo Muller gmbH, which will see the company introducing yogurt and dairy products in the U.S. Generally, food products have lower gross margins compared to beverages. Moreover, rising commodity costs will also impact the margins negatively. The management expects the incremental cost of commodities to top $800 million in 2012. ^[2] So we could witness some margin deterioration in the subsequent quarters on a sequential basis.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Gatorade Tops 1B Gallons in 2011, April 4, 2012, beverageworld.com [↩]
2. PepsiCo Earnings Preview: 2Q Profit Hurt By Higher Commodity Costs, Restructuring Efforts, July 24, 2012, ibtimes.com [↩]