North American Beverage Weakness Expected To Continue In The Second Quarter For PepsiCo

PepsiCo‘s (NYSE:PEP) stock fell from close to $120 at the start of the year to $95 in May, despite exceeding consensus expectations on revenue and earnings in both Q4 2017 and Q1 2018. It has rebounded since then, but the shares are still down roughly 8% year-to-date. Continued weakness in the North American Beverage (NAB) segment did not hamper the company’s results as much in the first quarter, as its other segments were able to deliver strong growth to offset the weakness. Moreover, beyond trademark Pepsi, NAB is performing reasonably well, in the face of a highly competitive environment. PepsiCo has in the past stated its intentions to increase the marketing spend behind its core beverage portfolio, to halt the decline, and this sentiment was again echoed in the first quarter earnings conference call. This factor will help the company, but its impact is expected to be reflected only after a few quarters. In the second quarter, while both revenue and earnings are expected to increase, the higher marketing expenditure is anticipated to pressure the bottom-line.

We have a $119 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 for our interactive dashboard for Pepsi’s 2Q, to gauge their impact on the revenue, earnings, and price per share metrics.

Factors That May Impact The Performance In The Future

1. Increased Marketing Spend For Core Beverages: While PepsiCo has moderately increased media spend over the past three years, its biggest competitor – Coca-Cola – has done so by a substantial margin. While this has benefited the latter, PepsiCo has struggled as a result. In response to this, the company has allocated increased media to trademark Pepsi. It has also launched a new “Pepsi Generations” campaign, with PepsiCo expecting improving sales and market share as an outcome. On the other hand, this step could also pressure the operating margins of the company, offsetting any benefit received from the productivity initiatives implemented by the company to induce cost savings.

2. Focus On Healthy Snacks: In order to meet the evolving needs of customers globally, PepsiCo is shifting its portfolio to a wider range termed as “Everyday Nutrition Products.” The company now derives approximately 45% of its revenues from these “Guilt Free Products” indicating that it has transformed its portfolio toward healthier products according to the new customer preferences. These products include “diet and other beverages that contain 70 calories or less from added sugar per 12-ounce serving and snacks with low levels of sodium and saturated fat” as well as “everyday nutrition products” – products with nutrients like grains, fruits and vegetables, protein, unsweetened tea, and water. Frito-Lay is also pushing toward a premiumization of its products to fuel its revenue and margin growth. Consumers have been moving away from eating unhealthy products, which has put pressure on the volumes. Hence, by concentrating on premium brands, there can be a shift from low-priced, high-volume products to the high-priced, low-volume range, which may result in top and bottom line growth.

3. Acquisition Of Brands Such As Bare Foods: The acquisition of Bare Foods fits perfectly with PepsiCo’s plan of focusing on its ‘Better For You’ portfolio. Moreover, it also provides the company with a line of products that are already doing well. Consequently, PepsiCo would not have to undertake the considerable investment needed to build the products from scratch, as well as the marketing dollars needed to establish a customer base. On the other hand, for Bare Foods, it could not have been a better offer. The brand gets to operate independently, while having access to PepsiCo’s immense distribution network, and vast coffers needed to increase production and the marketing of its products.

4. Growth Of Healthier Beverages: With the growth of its beverage business slowing down, as a result of sluggish soda sales, the healthy products segment will be a focus for the company in the future to drive its sales. PepsiCo’s tea portfolio, with brands including Lipton and Pure Leaf, has grown retail sales in the range of mid-single digits to as high as 21% over the past 17 quarters. In enhanced water, both LIFWTR and the newly launched Bubly have grown nicely. KeVita, PepsiCo’s line of premium organic live probiotic beverages, grew retail sales 50% in Q1, following 66% growth for the full year 2017. The growth of these brands is highly important for the company, as significant growth here may help to offset some of the weakness in the core portfolio.

5. Importance Of Frito-Lay: Frito-Lay North America (FLNA) grew revenues by 3% in the first quarter, driven by 2 percentage points growth of price, and one of volume. While Frito-Lay North America (FLNA) contributes to roughly a quarter of the company’s revenues, its share of the total operating profit is about 42%. We expect the strong growth rates of FLNA to continue in the future, boosted by the segment’s foray into new products and healthy snacks. For example, due to the success of Lay’s Poppables, launched in 2017, FLNA extended the Poppables product line-up with the introduction of new Lay’s Poppables Honey Barbecue and a 12-count multipack of Poppables Sea Salt. The company has also extended the Simply sub-line (which offers natural and organic versions of popular snack brands) by introducing new package varieties with the Simply variety pack and a three-flavor lineup of single-serve packages for Simply Lay’s, Cheetos, and Doritos offerings.

6. Focus On The E-Commerce Space: With online grocery shopping rising at a phenomenal pace, PepsiCo is placing a big bet on the online space. The company is making an increasing effort to address the growth opportunities across eGrocery, pureplay, urban grocery delivery, direct-to-business, and direct-to-consumer models. Keeping this in mind, the cola giant has developed a team of roughly 200 e-commerce professionals which has been tasked with capturing growth in this rapidly growing segment.  PepsiCo’s efforts seem to be working well, as the company has witnessed tremendous growth through its e-commerce channels, with its digital business garnering approximately $1 billion in annualized retail sales.

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