(PEP) PepsiCo Posts Mixed Third Quarter – Keeps View

PepsiCo Inc.’s (PEP) third quarter 2012 earnings per share declined 8% year over year to $1.20 hurt by revenue decline and currency headwinds. Foreign exchange negatively affected earnings by 4% as this food and beverage company carries out a substantial part of its business outside U.S. However, earnings edged past the Zacks Consensus Estimate of $1.16. PepsiCo also affirmed its previously provided 2012 outlook.

Top-Line and Margin Details

Total sales in the quarter declined 5% year over year to $16.65 billion mainly due to structural changes and foreign exchange headwinds. Both foreign exchange and the beverage re-franchising transactions in Mexico and China pulled down revenue by 5% each, exactly in line with management guidance.

Excluding these two factors, revenue increased 5% on an organic basis helped mainly by price increases. Price/mix added 4% while volumes added 1% to total revenue growth. Revenues, however, missed the Zacks Consensus Estimate of $16.88 billion.

PepsiCo is the largest food and beverage company in North America and the second largest in the world. The Global Snacks volume grew 6% while global beverage volume was up 3%.

PepsiCo is boosting its existing brands and categories with stepped-up marketing and innovations, especially in its American beverage business, which are expected to drive revenue growth and also enable increased price realization in the long run. In the quarter, the company substantially increased its media spending.

To counter the maturing North American market, PepsiCo has lately concentrated more on its international business, which is relatively untapped by other companies. Emerging and developing market revenue was down 13%. However, excluding the impact of the beverage re-franchising actions in China and Mexico and foreign exchange headwinds, organic revenue in the these markets was up 11%.

Core operating profit in the quarter was down 8% (down 5% in constant currency) to $2.76 billion mainly due to currency headwinds, increased ingredient costs and higher marketing and pension expenses.

Segment Details

PepsiCo Americas Foods (PAF): The segment, which makes popular foods like Lay’s potato chips, Cheetos and Quaker-brand cereals and snacks recorded revenue growth of 2.5% (organically up 6%) to $5.77 billion. Price/mix gains, volume growth, innovation and higher marketing spend boosted revenue of the segment. The segment’s core operating profit declined 1% in constant currency to $1.33 billion million due to high commodity and advertising/marketing costs.

Frito-Lay North America (FLNA): Revenue increased 3% year over year (both reported and organic) to $3.27 billion fueled both by price/mix and volume growth. Core operating profit was up 1% to $925 million as top-line growth and productivity benefits partially offset the commodity cost headwinds and increased marketing expenses.

Latin America Foods (LAF): Revenue increased 2% year over year to $1.88 billion. Foreign exchange pulled down revenues by 13%. Organically revenues increased 13% driven by price/mix and organic volume gains. Core operating profit was flat in constant currency terms at $248 million due to commodity cost increases and higher marketing spend.

Quaker Foods North America (QFNA): Revenue was flat (up 0.5% in constant currency) at $615 million as volume gains were offset by price/mix declines. Core operating profit declined 11% in constant currency to $155 million due to high commodity and marketing costs.

PepsiCo Americas Beverages (PAB): Net revenue of this segment, which makes popular beverages like Pepsi, Mountain Dew, Diet Pepsi, and 7UP, slipped 7% year over year to $5.53 billion mainly due to currency headwinds and re-franchising of the Mexican beverage business.

Organically, revenues were flat as price/mix gains were offset by bottler case volume decline. Core operating profit declined 13% in constant currency in the quarter to $870 million due to high commodity costs and increased marketing/advertising spend.

Europe: Net revenue in the segment declined 6% year over year to $3.69 billion mainly due to foreign exchange headwinds. Organically revenues increased 7%, benefited by price/mix gains and healthy growth in Russia. Core operating profit was up 3% year over year in constant currency to $486 million driven largely by productivity savings.

Asia, Middle East & Africa (AMEA): Net revenue declined 21% to $1.66 billion mainly due to re-franchising of beverage business in China and foreign exchange headwinds. Organically revenue grew 10% driven by volume growth for both snacks and beverages. Core operating profit was up 14% year over year in constant currency to $323 million as pricing and volume tailwinds partially offset the impact from higher commodity costs.


The company maintained its previously provided top-and bottom-line outlook for 2012. PepsiCo projects core constant currency earnings to decline in 2012 by approximately 5% from 2011 core earnings of $4.40. Currency headwinds are expected to reduce earnings growth by 3%, in line with prior guidance. The Zacks Consensus Estimate stands at $4.06.

Constant currency revenues are expected to grow in the low single digits, including headwinds from re-franchising of the beverage business in China and Mexico. Excluding such changes, revenues are expected to grow in the mid-single-digits, which are in line with the previous guidance.

Further, for 2012, the company expects to generate $8 billion in operating cash flow. Capital expenditures are expected to decline by 10% in 2012. Moreover, the company hopes to buy back shares worth $3 billion and pay $3.3 billion in dividends.

Our Recommendation

We currently have a Neutral recommendation on PepsiCo. The stock carries a Zacks #3 Rank (a short-term Hold rating).

We are encouraged by the company’s strong brand portfolio, its product and geographic diversity and solid cash flow generation. Moreover, PepsiCo’s marketing support investments, brand building innovation and cost saving efforts will boost growth. However, we prefer to remain on the sidelines until we see some meaningful impact of these investments on the operating results.

Moreover, a challenging consumer spending environment combined with currency headwinds raise concern. PepsiCo also faces strong competition from The Coca-Cola Company (KO). In the U.S. measured channels, The Coca-Cola Company commands a larger share of carbonated soft drink (CSD) consumption. Coca-Cola also enjoys higher market share in many markets outside the United States than PepsiCo.

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