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Innovations & Emerging Market Presence Bode Well for PepsiCo

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PepsiCo, Inc. PEP has been trying to gain traction through product launches, fortifying developing/emerging market presence, aggressive marketing, productivity improvement and cost-saving initiatives. However, higher input costs and dismal performance by its North America Beverages ("NAB") division have been pressing problems.

Efforts to Boost Sales Bode Well

Sales for beverage giant PepsiCo have remained subdued in the recent quarters, due to growing health and wellness consciousness. Consumer tastes are rapidly shifting from carbonated soft drinks (CSDs) to non-carbonated beverages. Sluggish CSD volumes are pressing concerns for this beverage giant as well as for other nonalcoholic beverage companies such as The Coca-Cola Company KO, Monster Beverage Corporation MNST and Dr Pepper Snapple Group, Inc. DPS. Shares of PepsiCo have decreased 17% year to date, underperforming the Zacks Soft Beverages industry that has declined 12.3% over the same period.


Nonetheless, PepsiCo is gradually reshuffling its portfolio toward healthier options. Currently, a major portion of PepsiCo’s total net revenues comes from “Guilt-Free” products, more than half of which comes from the “Everyday Nutrition” category. This percentage is likely to increase, given the company’s stepped-up innovation and focus on adapting to changing consumer preferences. The better-for-you and good-for-you products have increased the percentage of the company’s total portfolio from 38% in 2006 to 50% in 2017. Retail sales of KeVita, PepsiCo’s line of premium organic probiotic beverages, grew 50% in the first quarter.

PepsiCo is one of the top global positions in the non-alcoholic beverage and snack food industries, anchored by cherished brands like Pepsi, Gatorade, Tropicana, Lays, Doritos, and Quaker, among others. PepsiCo has broadened its beverage portfolio to include more non-carbonated beverages to decrease the dependence on colas; keeping in mind the slowdown in CSD volumes. PepsiCo’s non-carbonated beverage volume mix increased 7 percentage points since 2010.

The company has been growing its value share in a number of its fastest-growing categories including tea, enhanced water and sparkling water.

Emerging/Developing Market Presence Drives Growth

Last month, the beverage giant reported first quarter of 2018 results, wherein core earnings increased 3% year over year on 4.3% revenue growth. The improvement was mainly attributable to the strong performances by its international divisions, propelled by higher revenue growth in the developing and emerging markets.

In the first quarter of 2018, the company registered 8% organic revenue growth in its developing and emerging markets as a group, reflecting acceleration from 6.5% improvement recorded in the fourth quarter of 2017. Within Latin America, organic revenues grew 10% in Mexico, high teens in Brazil and 20% in Argentina in the quarter. Notably, in Asia, Middle East and North Africa or AMENA division, PepsiCo witnessed strong double-digit organic revenue growth in China, India, Egypt and Pakistan.

The company has almost tripled its global footprint from 28 markets at the beginning of 2015 to 77 markets at present.

Weak NAB Results are Cause of Concern

In first-quarter 2018, the NAB division reported dismal results with revenues and operating profit decreasing 1% and 22%, respectively. Volumes declined 2.5%, owing to 4% decline in CSDs and 1% decrease in Non CSDs.

The non-carbonated beverage volume decreased mainly due to low-single-digit declines in Gatorade sports drinks, and juice and juice drinks portfolio, partially offset by a low-single-digit increase in the overall water portfolio. Acquisitions had a nominal positive contribution to the volume performance.

Operating profit was affected by operating cost inflation as well as higher raw material costs, and a bonus extended to certain U.S. employees in connection with the TCJ Act.

Higher Input Costs a Woe

The company has stepped up productivity and cost-saving initiatives to boost profitability by reducing overall costs. PepsiCo’s productivity program aims to deliver $1 billion in annual productivity savings.

However, this Zacks Rank #3 (Hold) company’s adjusted gross margin fell 75 basis points (bps) year over year in the last reported quarter. The downside was mainly due to higher input costs. PepsiCo’s arch rival, Coca-Cola also faced a significant rise in freight costs in its North America segment in the first quarter of 2018. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Meanwhile, PepsiCo expects its gross margin to remain under pressure in fiscal 2018 due to the higher input costs. The company has been undertaking various productivity initiatives to improve its margins. However, the favorable impact of productivity measures is expected to be offset by investments in PepsiCo’s growth initiatives.

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