Pepsi Begins 2014 with Strong Q1 Earnings

PepsiCo, Inc. (PEP) began 2014 on a solid note like peer The Coca-Cola Company (KO) which reported earlier this week. The food/beverage giant beat the Zacks Consensus Estimate for both earnings and revenues as snacks once again offset weakness in beverages. Pepsi’s shares rose 2% in pre-market trading.

With the latest earnings beat, Pepsi has delivered four straight positive earnings surprises with an average beat of 7.12%.

Pepsi’s first-quarter 2014 core earnings per share of 81 cents beat the Zacks Consensus Estimate of 75 cents by about 8.0%. However, core earnings exclude a 2-cent gain from the sale of assets in Europe. Including the gain, earnings stood at 83 cents, up 7% year over year driven by strong organic revenue gains and solid margins. Currency hurt the fourth-quarter earnings by 3.0%, significantly lower than management’s expectations of 6%. In constant currency terms, adjusted earnings grew 10%.

Despite difficult consumer spending environment, lower-than-expected currency headwinds, aggressive marketplace investments, better execution, lower taxes and productivity gains boosted profits in the quarter.

Core earnings exclude the impact of restructuring and impairment charges and mark-to-market gains. Including these factors, reported earnings per share were 79 cents, up 15.0% year over year.

Top-Line and Volume Growth

Total sales in the quarter were flat year over year at $12.62 billion. However, structural changes, mainly beverage re-franchising transaction in Vietnam, pulled down revenues by 0.5% in line with management’s expectations. Foreign exchange hurt revenue growth by 3.0%, lower than management’s expectation of 4%. Revenues also beat the Zacks Consensus Estimate of $12.47 billion by 1.2%.

Excluding these factors, revenues increased 4.0% on an organic basis. Better volumes, strong snacks performance, improvement in Europe and sales gain in developing/emerging market offset a softer American beverage performance and weakness in Mexico.

PepsiCo witnessed an effective net pricing gain of 3% in the quarter, lower than the past three quarters. Volumes increased 1% in the quarter, slightly better than flat growth in the last quarter.

While organic snacks volumes grew 2%, beverages were flat in the quarter.

Organic volume of the American snacks segment increased 1%, slowing down from 3% seen last quarter. While volumes remained strong in the Frito-Lay North America segment, it declined in the Latin American snacks business due to weak revenues in Mexico. Higher food and beverage taxes in Mexico hurt revenues in the quarter. Organic snacks volumes grew 3% in Europe and 4% in developing and emerging markets.

As regards beverages, while Pepsi’s American and European volumes improved, developing/emerging market volumes declined from the last quarter.

Organic beverage volumes increased 3.0% in Europe but declined 1% in developing/emerging countries.

In the Americas, beverage volumes remained flat, though improving sequentially. However, while non-carbonated beverages’ volume grew in the quarter, carbonated soft drinks (CSD) remained a weak spot due to category headwinds.

Last month, Beverage Digest, a leading beverage industry newsletter said that CSD volumes declined 3% in 2013 — the ninth straight year of decline. The CSD category is suffering due to growing health consciousness since consumers have become particularly vigilant about the use of artificial sweeteners, high sugar content and related obesity concerns. Among CSDs, the cola segment particularly has come under fire as consumers are opting for alternative beverage offerings. Also, possible new taxes on sugar-sweetened beverages and growing regulatory pressures are affecting CSD sales. These challenges have also been felt by other major soft drink makers — The Coca-Cola Company and Dr Pepper Snapple Group, Inc. (DPS) — leading to lower volumes and weak sales.

PepsiCo has increased marketing investments and is driving package and product innovation to boost its American beverage business.

Margins Improve

Core gross margins improved 40 basis points (bps) in the quarter helped by effective revenue management strategies and productivity gains. Core constant currency operating profit (including gain on sale of European assets) improved 7.0% to $1.87 billion in the quarter. Core operating margins grew 54 bps as organic revenues growth and productivity gains offset headwinds from higher operating and advertising/marketing costs.

2014 Outlook Maintained

Management maintained its previously provided outlook for 2014. In 2014, Pepsi expects core constant currency earnings per share to be approximately $4.50, representing an increase of 7% from $4.37 reported in 2013. The target is in line with management’s long-term goal of high single-digit core constant currency earnings 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.

Currency is expected to hurt 2014 earnings per share and revenues by 4% and 3%, respectively.

Commodity inflation is expected in the low single-digit range in 2014. Productivity savings are expected to amount to $1 billion in 2014, which will be used to offset headwinds from cost inflation and thereafter, reinvest in the business. The core tax rate is expected to be approximately 25% for 2014, slightly lower than the 2013 level. Moreover, interest expenses are expected to be higher than 2013 due to increased debt balances.

Also, management plans to increase cash returns to shareholders in 2014 by 35% to $8.7 billion through significant hikes in dividends and share repurchases.

Pepsi carries a Zacks Rank #3 (Hold).

A favorably-placed beverage company is Monster Beverage Corporation (MNST), which carries a Zacks Rank #2 (Buy).

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