Will The Weakness In The North American Beverages Segment Continue For PepsiCo In The First Quarter?

by Trefis Team
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PepsiCo (NYSE:PEP) is set to report its first quarter earnings on April 26, wherein revenues are expected to increase to $12.36 billion, while the earnings are estimated to decline by 1 cent to 93 cents, as compared to the prior year quarter. While revenue growth is expected to be driven by the Frito-Lay segment in North America, and the international segments, weakness in North American Beverages (NAB) may pressure the margins. Furthermore, PEP expects to make a $1.4 billion discretionary pension contribution in the first quarter of 2018, which would also play a role in the decline in the earnings.

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.

Softness In The North American Beverage Market

A neglect of the core brands had been highlighted to be the main factor driving the weakness in the North American Beverages segment. While the company has been undertaking a number of steps, such as increasing the advertising behind these brands, the impact will take a few quarters to be fully realized.  Hence, while the trends continued to remain poor in the segment in Q4 2017, the metrics should improve sequentially as FY 2018 rolls on.

PepsiCo is also focusing on other avenues of growth, such as ready-to-drink teas and coffees, and bottled and sparkling water. In this regard, it is making an effort to return its tea brands (through a joint venture with Unilever) – Brisk, Lipton, and Pure Leaf – back to positive growth, by launching new flavors and re-advertising the core brands. PepsiCo has also partnered with Starbucks in the ready-to-drink coffee business, with their strong innovation pipeline ensuring growth in the years to come.

With water being a big and fast growing segment, it is imperative for PepsiCo to have a foothold in all its forms, such as still, sparkling, flavored, etc. The company launched LIFEWTR, an electrolytic water, in FY 2017, and the brand is reported to be performing well. PepsiCo recently launched Bubly, a flavored sparkling water drink, and will be playing catch-up to established brands such as Perrier, San Pellegrino, and National Beverage’s LaCroix brand. The tremendous growth in the water segment 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.

Importance Of The Frito-Lay Segment

In FY 2017, while Frito-Lay North America (FLNA) contributed to roughly a quarter of the company’s revenues, its share of the total operating profit was 42%, similar to its performance in 2016. According to our estimates, 38% of PepsiCo’s valuation comes from this division, which has posted an average annual revenue growth of 3% in the past three years, and an average 3-year operating profit improvement of 6%. PepsiCo’s dominance in this business is critical to its long-term growth, as a moderate increase in Frito-Lay’s revenue can compensate for a significant decline in the revenue of its beverage division. This is primarily because Frito-Lay’s EBITDA margins are almost double those of the North American Beverages division.

We expect the strong growth rates of FLNA to continue in the future, boosted by the segment’s foray into healthy snacks. Moreover, the segment has ensured its brands are available across multiple price points. For example, at the bottom end of the segment, Frito-Lay has Cracker Jack as a brand offering high value for money. Similarly, Taqueros was made available in dollar stores and other retail outlets that typically attract value-seeking consumers. Meanwhile, at the other end of the spectrum, Frito-Lay made its premium products available in high-end stores (such as Citarella) and the deli sections of grocery chains in order to create the right perception of these products.

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