PepsiCo (NYSE:PEP) reported strong first quarter results backed by 4.4% organic (adjusted for structural changes and foreign exchange translation) growth in consolidated net revenues and a core EPS (excluding the impact of commodity mark-to-market and other non-recurring charges) growth of 12% y-o-y. The company’s core operating margins improved by 70 basis points over last year led by muted commodity inflation during the period coupled with results from its ongoing productivity program.
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Within its Americas Foods division, Frito-Lay North America posted healthy 4% organic net revenue growth primarily driven by growth in volumes. Internationally, while the company witnessed modest organic net revenue growth in its Europe business amid troubled times, its operations in emerging and developing markets posted strong organic revenue growth of 12% y-o-y. However, PepsiCo Americas beverage unit realized flat net revenues growth as higher net pricing was offset by lower volumes. 
Frito-Lay North America Drives Healthy Growth
According to our estimates, Frito-Lay North America is the most valuable division of PepsiCo that makes up more than one-third of our valuation estimate for the company. Frito-Lay’s organic net revenue increased 4% y-o-y driven by 4% organic volume growth with flat effective net pricing during the first quarter. Strong revenue growth in the category backed by volume growth reinforces the company’s leading market position in the North America snacks market. The company already sells more brands in the segment than any other player occupying majority of shelf space in the retail outlets. 
Revenues form PepsiCo’s Stacy’s pita chips increased by 21% while volumes from Sabra, which offers packaged Mediterranean dips such as hummus increased sharply by 16%.  High growth from these premium brands reflects the company’s strong position in the segment and its potential to tap value from increased consumer focus on healthy bites. Productivity improvements implemented as a part of its three years, $3 billion productivity plan further helped expand core operating income from the division by 5% y-o-y.
Emerging Markets Operations Show Significant Growth
Although reported net revenues from the markets classified as “Emerging and Developing” by the company grew by just 1% during the quarter, adjusting for the negative impact of refranchising of their bottling operations in China and unfavorable foreign currency translation, organic net revenues form these markets grew by 12% y-o-y. PepsiCo’s snacks and beverages business in the emerging and developing markets witnessed organic revenue growth of 14% and 9% respectively.
Within the emerging markets, Saudi Arabia, Pakistan, Vietnam, and the Philippines, witnessed significantly strong growth in organic revenues, each growing in excess of 20% while percentage growth form Jordan and Egypt was in high teens. However, staggering volume growth seen from China in both the company’s snacks and beverages categories of 47% and 17% respectively, is of great significance, especially in light of the rapidly slowing growth of its prime competitor in the beverage category. (See More On This: Coca-Cola Earnings Reflect Its International Strength) Not just that, the company’s operating margins improved by 450 basis points in the Asia, Middle East & Africa (AMEA) region, even when its expenditure on marketing and advertisements has been increasing. This indicates PepsiCo’s 2011 strategic alliance with Tingyi that operates China’s most extensive bottling and distributing network is paying off really well and has put the company’s operations in the humungous beverage market of China in a fast lane.
North American Beverages Volumes Decline
PepsiCo reported flat organic growth in revenues for the first quarter in the Americas beverage operations which was primarily dragged by 3% decline in volumes amid higher net pricing. Volume decline was specifically significant in North American sparkling category (down by mid single digits) as the still beverages volumes declined by just 1% in the region. However, core constant currency profits of the division increased 4% driven by favorable net pricing and productivity gains.
The company has played down the decline in volumes in the segment, pointing at higher value creation by following pricing and innovation strategy in the profitable liquid refreshment beverages (LRB) segment. We believe that while this strategy may work well for the company in the still category where it holds some really well established premium brands, like Gatorade, it may have to face heat form some leading brands in the sparkling category. Moreover, sacrificing volume share in order to gain value share is an unsustainable strategy in the long-run and it would only be successful if the company is really able to re-invent the sparkling category by investing realized incremental value in R&D. However, there are inherent risks associated with this strategy which are even higher than those associated with creating a completely new category as the company is sacrificing its existing market share which may not always be re-gained if the new launch does not live up to the expectations. So, investors should be concerned if this trend persists over the next few quarters.