What Could Drive PepsiCo’s Earnings Decline In Q2 2019?

PepsiCo (NASDAQ: PEP), is set to announce its Q2 2019 results on July 9, 2019. The company is expected to report revenue of $16.4 billion in Q2 2019, marking a growth of 2% over $16.1 billion in Q2 2018. Higher revenue is expected to be driven by sustained strong growth in the Frito-Lay segment, effective net pricing and higher volumes for healthy snacks, juice and water products, and non-carbonated drinks (NCDs), partially offset by sluggish demand for ready-to-eat cereals and carbonated beverages. Adjusted earnings are expected to come in at $1.50 per share in Q2 2019, lower than $1.61/share in the year-ago period. The decline in earnings is expected to be driven by a higher effective tax rate, increased commodity prices, marketing cost, and incremental investments by the company to strengthen its business.

We have summarized the key expectations in our interactive dashboard – How Is PepsiCo Expected To Fare In Q2 2019 And What Would The Company Look Like By End Of 2020? In addition, here is more Consumer Staples data.

A Quick Look At PEP’s Revenue Segments

PEP reported revenue of $64.7 billion in FY 2018. The major revenue sources were as follows-

• Frito-Lay North America (FLNA): $16.3 billion revenue in 2018 (25% of total revenue). FLNA makes, markets, distributes, and sells branded snack foods to independent distributors and retailers.
• Quaker Foods North America (QFNA): $2.5 billion revenue in 2018 (4% of total revenue). Either independently or in conjunction with third parties, QFNA makes, markets, distributes, and sells cereals, rice, pasta and other branded products.
• North America Beverages (NAB): $21.1 billion revenue in 2018 (33% of total revenue). NAB makes, markets and sells beverage concentrates, fountain syrups, and finished goods under various beverage brands.
• Latin America: $7.4 billion revenue in 2018 (11% of total revenue). PEP makes, markets, distributes, and sells a number of snack food brands and sells ready-to-drink tea products through an international joint venture with Unilever in Latin America.
• Europe Sub-Saharan Africa (ESSA): $11.5 billion revenue in 2018 (18% of total revenue). Under this segment, PEP sells snacks and beverages along with a number of leading dairy products in the region.
• Asia, Middle East, North Africa (AMENA): $5.9 billion revenue in 2018 (9% of total revenue). AMENA also makes, markets, distributes, and sells beverage concentrates, fountain syrups, and finished goods under various beverage brands.

A] Revenue Trend

Frito-Lay North America (FLNA)

• Revenue from FLNA is expected to continue its strong growth, driven by effective net pricing and higher volume.
• Volume growth is likely to be driven by strong sales of its trademark Doritos and Ruffles.

Quaker Foods North America (QFNA)

• This segment continues to be the biggest drag on PEP’s revenue growth.
• Revenue growth is expected to remain sluggish, driven by unfavorable volume-price mix, led by a decline in ready-to-eat cereals.

North America Beverages (NAB)

• The NAB segment revenue has steadily increased through 2018 and posted a y-o-y increase in Q1 2019.
• The trend is expected to continue in Q2 2019, driven by higher demand for its non-carbonated beverage portfolio and increased pricing.

Latin America

• Though revenue has largely increased over recent quarters, it is expected to remain almost flat in Q2 2019, driven by effective net pricing, partially offset by impact of unfavorable foreign exchange.

Europe, Sub-Saharan Africa (ESSA)

• ESSA revenue is expected to register a y-o-y increase in Q2 2019, led by the impact of the SodaStream acquisition, as well as effective net pricing, partially offset by the impact of unfavorable foreign exchange.

Asia, Middle East and North Africa (AMENA)

• AMENA revenue is expected to remain flat in Q2 2019, driven by effective volume-price mix and higher sales of snacks and NCDs, offset by unfavorable foreign exchange and refranchising of a portion of the beverage business in Thailand.

B] Expense and Profitability Trend

Though total expenses have trended lower since Q2 2018, they have largely increased on a y-o-y basis, except in Q3 and Q4 2018 due to tax benefits received. We expect expenses to go up in Q2 2019, driven by higher commodity prices, labor cost, and increased investment in advertising and marketing, partially offset by productivity gains.

• Cost of Goods Sold: Cost of sales as a % of revenue has consistently increased over recent quarters. We expect this trend to continue in Q2 2019, driven by higher commodity prices and labor cost, partially offset by higher volume and benefits of refranchising.
• SG&A: SG&A expense has largely increased through 2018, with a y-o-y growth in Q1 2019. We expect cost to increase in Q2 2019, driven by higher marketing and advertising cost, along with distribution expenses, partially offset by the benefits of the 2019 Productivity Program beginning to kick in gradually.
• Effective Tax Rate: Effective tax rate saw wide fluctuations through the recent quarters following the implementation of the TCJ Act. We expect effective tax rate to remain almost flat on y-o-y basis in Q2 2019.

Net income margin is expected to be slightly lower in Q2 2019 compared to 11.3% reported in the year-ago period, driven by higher cost of sales and SG&A, partially offset by an increase in the revenue base.

Full Year Outlook

• For the full year, we expect the company’s revenues to grow by 3.1% to $66.7 billion in 2019, and further by 3.8% to $69.2 billion in 2020, driven by growth in the company’s healthy snacks, sports drinks, and non-carbonated beverage portfolio.
• An effective tax rate of 21% in 2019 (compared to tax benefits received in 2018), incremental investments by the company to strengthen its business, and absence of gains from sale of assets, unlike in 2018, is expected to lead to a sharp drop in net income margin to 8.5% in 2019 from 19.4% in 2018.
• However, benefits of the recently announced 2019 Productivity Plan is expected to reflect in the year 2020, when net income margins are expected to grow to 8.7%.

Trefis has a price estimate of $128 per share for PepsiCo’s stock.

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