Can PepsiCo Halt The Decline In The North American Beverage Segment In The Fourth Quarter?

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PepsiCo

PepsiCo (NYSE:PEP) is set to report its fourth quarter earnings on February 13th, before the markets open. Analysts are expecting a revenue of $19.37 billion on earnings of $1.30 per share in the fourth quarter, and $63.41 billion in sales and an EPS of $5.22 for the full year. A poor showing in the North American beverage market in the third quarter prompted the downgrading of the company’s organic revenue growth target to 2.3% for FY 2017, from 3% earlier. PepsiCo, meanwhile, expects core earnings to come in at $5.23 per share, benefiting from a reduced impact of foreign currency translations on revenue growth and earnings by 1 percentage point, from 2 percentage points expected earlier.

With the portfolio leaning more towards the more profitable Frito Lay segment, the margins can be expected to hold up. A shift in strategy for the company, by focusing more on the low-calorie, healthy drinks, resulted in a neglect of the core brands, inducing a big drop in sales in the North American beverages segment in the third quarter. This forced the company to raise its marketing spend on the core brands, which may stem the decline going forward. However, a focus on healthier beverages is imperative, given the change in consumer preferences.

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We have a $125 price estimate for PepsiCo, which is higher than the current market price. The charts have been made using our new, interactive platform. You can modify the different driver assumptions by clicking here, to gauge their impact on the earnings and price per share metrics.

Weakness In The North American Beverages Segment

PepsiCo’s chief executive, Indra Nooyi, stated that the company had neglected its core brands by focusing mostly on its low-calorie, healthier drinks, a contributing factor to a first drop in the quarterly sales in the company’s biggest segment in two years. An excessive amount of the media spending and shelf space was allocated to these new drinks, such as premium bottled water brand LIFEWTR and a sparkling lemonade named Lemon Lemon, at the expense of Pepsi and Mountain Dew. This resultant fall in revenue, from the increased shift in focus, has made the company believe that when new products are launched, the company should go for new shelf space, instead of diluting that of the core brands. The company also intends on upping its marketing spend on its core brands going forward.

Soda consumption in the US has been declining for the past 12 years, as consumers look toward healthier options. Hence, a focus on these beverages has been a necessary move for PepsiCo. As it adapts to changing consumer preferences, PepsiCo believes that healthier products will be key for long-term growth. In order to meet the evolving needs of customers globally, the company is shifting its beverage portfolio towards these healthier beverages and aims for two-thirds of its global beverage portfolio volumes to contain fewer than 100 calories from added sugar per 12-ounce serving, from 40% currently. However, while the focus on healthier products is imperative, given the evolving needs and preferences of customers, PepsiCo still garners a significant portion of its revenues from its beverages, and hence, it is a segment that needs to be protected.

Diversifying Beverage Portfolio

As the beverage industry undergoes a transformation with carbonated soft drinks losing their position and consumers preferring “healthier” beverages, cola giants have focused their attention on other avenues to spur their sales. One such route is the sparkling water category which has witnessed spectacular growth rates. The market for sparkling water is set to continue its strong growth in the next few years, driven by the introduction of new and innovative flavors, as well as its image as a healthy alternative to carbonated drinks.  The Coca-Cola Company (NYSE:KO) and PepsiCo have to play catch-up to established brands such as Perrier, San Pellegrino, and National Beverage’s LaCroix brand. While Coca-Cola announced the acquisition of premium sparkling mineral water brand Topo Chico in the beginning of October 2017, PepsiCo recently announced the launch of its own flavored sparkling water brand called Bubly.

Given that nationally, more than $2.3 billion worth of bottled sparkling water is sold every year, according to consumer market researcher Information Resources Inc., it is definitely a significant market for PepsiCo to ply its trade. In the first half of 2017, this market grew by almost 40% in terms of volume, with double-digit growth reported in dollar sales. This tremendous growth is expected to continue in the future as well, as the soda sales contract, and consumers look towards sparkling water to satisfy their cravings for carbonation.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for PepsiCo

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