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PepsiCo Beats Earnings in 1Q13, Up Y/Y

Zacks Equity Research

PepsiCo Inc. (PEP) reported strong first-quarter earnings results beating both the Zacks Consensus Estimate as well as the year-ago number. The company also delivered positive top-line growth and strong margins while retaining its 2013 outlook.

2012 was a turning point for PepsiCo. In this year the company increased investments in brand building, market execution and innovation, improved productivity and efficiency, and drove significant cash flow generation, thereby setting a solid foundation for further growth and securing competitive advantage.

Earnings Discussion

PepsiCo’s first quarter 2013 earnings per share of 77 cents beat the Zacks Consensus Estimate of 71 cents per share by 8.5%. Earnings also improved almost 12% from year-ago levels driven largely by productivity gains from restructuring activities, strong margins as well as positive top-line growth. Earnings grew 13% on a constant currency basis.

Top-Line and Margin Details

Total sales in the quarter improved 1% year over year to $12.58 billion. Structural changes, mainly beverage re-franchising transaction in China pulled down revenues by 3%, in line with management's expectations. Foreign exchange hurt revenue growth by 0.5%, less than management's expectation of 1%. Excluding these factors, revenues increased 4.4% on an organic basis driven by an effective net pricing gain of 3% and volume growth of 1%. Both snacks and beverages showed positive organic volume growth with snacks growing 4% and beverages up 1%. Revenues, however, missed the Zacks Consensus Estimate of $12.68 billion.

The American foods business once again did well in the quarter, gaining from successful innovations and increased brand building investments. Emerging and developing market revenues also did well growing 12% on an organic basis (excluding the impact of structural changes). However, the American beverage business continued to be sluggish.

Core gross margins expanded 130 basis points (bps) in the quarter. Core constant currency operating profit improved 9% in the quarter to $1.80 billion despite an 11% increase in advertising and marketing costs driven mainly by productivity savings from its restructuring program. Core operating margins increased 80 bps in the quarter.

Segment Details

PepsiCo Americas Foods (PAF): The segment, which makes popular foods like Lay’s potato chips, Cheetos cheese flavored snacks and Quaker-brand cereals and snacks recorded revenue growth of 5% (organically up 6%) to $5.12 billion. Price/mix gains, volume growth and higher marketing spend boosted revenues of the segment. All the three sub-segments delivered positive organic growth in the quarter.

The segment’s core operating profit increased 7% in constant currency to $1.23 billion due to top-line growth and productivity initiatives.

Frito-Lay North America (FLNA): Revenues improved 4% year over year to $3.12 billion on both reported and organic basis. Revenues were driven by volume growth and improved market share trend due to stepped-up advertising support. Core operating profit was up 5% to $830 million driven by organic top-line growth and productivity benefits.

We believe the Frito-Lay business will continue to post steady top-line growth in 2013 driven by balanced growth in volume and price (as inflation is expected to subside).

Latin America Foods (:LAF): Revenues increased 11% year over year (14% organically) to $1.37 billion driven largely by price/mix gains. Organic volumes grew 1%.

Core operating profit improved 25% to $220 million in constant currency terms driven by sales growth and productivity gains which offset headwinds from higher commodity costs and marketing expenditures.

Quaker Foods North America (:QFNA): Revenues increased 2% (both reported and organic) to $634 million in the quarter driven largely by organic volume gains. Core constant currency operating profit declined 6% to $179 million due to high advertising and marketing costs.

PepsiCo Americas Beverages (PAB): Net revenue of this segment, which makes popular beverages like Pepsi, Mountain Dew, Diet Pepsi and 7UP, declined 1% year over year to $4.42 billion. Organically revenues were flat as price/mix gains offset headwinds from volume. Though volumes improved slightly in Latin-America, they declined in North America. Non-carbonated beverages volume declined 1% while carbonated soft drinks volume declined in mid single-digits in North America.

The company’s North American beverage business has been continuously delivering sluggish results, especially the colas. PepsiCo has been witnessing a slack in cola sales as consumers increasingly prefer drinks with low calorie content and are also looking for a variety of choices. In order to re-vitalize cola sales which are suffering due to their high calorie content, the company is developing evolutionary natural sweeteners and flavorings aimed at reducing calories with no compromise on taste.

Core operating profit improved 4% to $552 million in constant currency driven by pricing and productivity gains.

Europe: Net revenue in the segment improved 5% year over year (up 4% organically) to $1.94 billion driven by balanced growth of price/mix gains and volume. Both snacks and beverages showed organic volume growth. Core operating profit rose 14% year over year to $93 million in constant currency due to top-line growth and productivity benefits.

Asia, Middle East & Africa (AMEA): Net revenue declined 14% to $1.10 billion mainly due to re-franchising of the beverage business in China (which hurt revenues by 27%) and currency headwinds (2%). Organically, revenues grew 15% driven by organic volume growth for both snacks and beverages. Organically, snacks volumes grew 15% while beverages grew 10%.

Core operating profit improved 19% year over year to $185 million in constant currency due to organic top-line growth.

2013 Outlook Retained

PepsiCo continues to expect core constant currency earnings to increase in 2013 by 7% from 2012 core earnings of $4.10 per share. The target is in line with management’s long-term goal of high single-digit core constant currency earnings growth. Currency headwinds are expected to reduce earnings growth by approximately 1%, less than in 2012.

Excluding headwinds from currency and structural changes, organic revenues are expected to grow in the mid single-digit range, also in line with long-term targets. The structural changes are expected to pull down organic revenues by 1%.

Organic revenue growth is once again expected to be driven by strong growth in developing and emerging markets as well as increased investment behind innovation advertising/marketing. The company expects its advertising/marketing expense to increase at a rate equal to or higher than revenue growth. The company intends to step up innovation and marketing spend behind good-for-you products in 2013.

Commodity inflation is expected to be in the low single-digit range in 2013.  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 will be thereafter reinvested in the business.

PepsiCo currently carries a Zacks Rank #3 (Hold). Rival, The Coca-Cola Company (KO) reported mixed first-quarter results this week; beating on earnings and lagging on sales. Another beverage company, Dr Pepper Snapple (DPS) is expected to announce its first-quarter results next week.

You may consider investing in one of Coca-Cola’s bottling companies, Coca-Cola Amatil Limited (CCLAY) which carries a Zacks Rank #2 (Buy).

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