PepsiCo's Q3 Earnings Beat, Revs Miss

PepsiCo Inc.’s (PEP) third-quarter 2013 core earnings per share of $1.24 beat the Zacks Consensus Estimate of $1.17 per share by about 6.0% and year-ago level by 3.3%. The core earnings per share include a 1 cent gain from incremental investments. Price increases and productivity gains from restructuring activities led to the year-over-year increase in earnings.

Core earnings exclude the impact of mark-to-market adjustments on commodity hedges (worth 1 cent) and restructuring and integration charges. Including these factors, reported earnings per share were $1.23, up 1.7% year over year. Price increases and productivity gains from restructuring activities led to the year-over-year increase in earnings.

Top-Line and Volume Growth

Total sales in the quarter improved 1.5% year over year to $16.91 billion. However, structural changes, mainly beverage re-franchising transaction in China and Vietnam pulled down revenues by almost 0.5%. Foreign exchange hurt revenue growth by more than 1.0%. Revenues fell shy of the Zacks Consensus Estimate of $17.0 billion.

Excluding these factors, revenues increased 3.3% on an organic basis. Higher pricing, strong snacks performance, improvement in Europe and another quarter of healthy growth in emerging and developing markets drove organic revenue growth. PepsiCo is boosting its existing brands and categories with stepped-up marketing and innovations, which is driving market share gains.

PepsiCo witnessed an effective net pricing gain of 4% in the quarter, in line with the second quarter. Volumes, however, declined 1% in the quarter, compared to flat volume in the last quarter.

Both snacks and beverages showed positive organic volume growth with snacks growing 3% and beverages up 1.0%.

The American snacks businesses, especially the Frito-Lay North America and Latin American segments, once again did well in the quarter. Frito-Lay North America organic revenues grew 5% while it went up 14% for Latin America Foods. Frito-Lay recorded organic volume growth of 3%. Organic volume of the Latin American segment increased 3%. Both these divisions witnessed effective net pricing growth of 2% and 12%, respectively. Overall, PepsiCo Americas Foods saw organic volume growth of 3% and pricing growth of 5%.

The American beverage business continued to be sluggish and volumes declined 4.0%. Pepsi’s American beverage business has been consistently delivering sluggish results, especially the colas. Changing consumer preferences, increasing health consciousness, rising obesity concerns, possible new taxes on sugar-sweetened beverages and growing regulatory pressures are affecting the company’s carbonated beverage sales. PepsiCo has increased marketing investments and is driving package and product innovation to boost its American beverage business.

Organic volumes for snacks grew 3% in Europe whereas beverage volumes declined 1% in the region. In Asia, Middle East & Africa (:AMEA), organic volume grew in both snacks (up 4%) and beverages (up 7%), overruling the volatility in some markets like Egypt and India.

Margins Impressive

Core gross margins expanded 70 basis points (bps) in the quarter driven by strong pricing and effective revenue management. Core constant currency operating profit improved 1.8% in the quarter despite an 8% increase in advertising and marketing costs. Core operating margins grew 5 bps. Solid top-line growth and productivity savings from its restructuring program drove profits in the quarter.

2013 Outlook Retained

Given the company’s decent performance in the first nine months, management is now confident of meeting its 2013 targets. PepsiCo continues to expect core constant currency earnings per share to increase 7% year over year in 2013 from $4.10 per share reported in 2012.

However, the guidance incorporates the second-quarter Vietnam gain. The Vietnam gain is expected to offset currency headwinds and increased marketing investments. Currency headwinds are expected to hurt 2013 earnings by 2%, in line with prior expectations.

The earnings per share growth target is in line with management’s long-term goal of high single-digit growth.

Excluding headwinds from currency and structural changes, organic revenues are expected to grow in the mid single-digit range, also in line with the long-term targets as well as prior expectations. The structural changes in China and Vietnam as well as currency headwinds are expected to pull down organic revenues by 1% (same as prior expectation) and 2% ( higher than previous expectation of 1%).

Commodity inflation is expected to be in the low single-digit range in 2013, same with the prior expectation. The company expects its advertising/marketing expense to increase at a rate equal to or higher than revenue growth. The core tax rate is expected to be approximately 27% for 2013.

PepsiCo plans to reinvest any excess earnings to support brand building, innovation and improve productivity, especially in the U.S. Productivity savings are expected to amount to $900 million in 2013, which will be used to offset headwinds from cost inflation and thereafter, reinvest in the business.

PepsiCo expects to spend $6.4 billion to return value to shareholders in the form of dividends and share repurchases in 2013.

PepsiCo currently carries a Zacks Rank #3 (Hold). Some other players in the consumer staples industry, which look attractive at the current level include Coca-Cola HBC AG (CCH), Coca-Cola Enterprises Inc. (CCE) and Whole Foods Market Inc. (WFM). All these companies carry a Zacks Rank #2 (Buy).

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