Pepsi Q3 Earnings Beat as Emerging Market Gains, Ups View

PepsiCo, Inc. (PEP) sustained its first-half momentum in the third quarter as well.The food/beverage giant beat the Zacks Consensus Estimate for both earnings and revenues for the second time in a row on strong emerging market performance and increased pricing.

Moreover, the company raised its 2014 earnings guidance for the second time this year based on its strong year-to-date performance and an optimistic outlook for the rest of the year.

Pepsi’s shares rose 1.5% in pre-market trading. In fact, its share price has gone up almost 17% year to date.

Pepsi’s third-quarter 2014 core earnings per share of $1.36 comfortably beat the Zacks Consensus Estimate of $1.29 by 5.4%. Earnings increased 10% year over year driven by strong organic revenue gains and solid margins.

Currency hurt third-quarter earnings by 1%, lower than management’s expectations of 2%. In constant currency terms, adjusted earnings grew 11%.

Despite a difficult operating environment in developed countries and nagging volatility in emerging countries, increased product pricing, lower-than-expected currency headwinds, lower taxes, better execution and productivity gains boosted profits in the quarter.

Core earnings exclude the impact of restructuring and impairment charges and mark-to-market losses on commodity hedges. Including these factors, reported earnings per share were $1.32, up 7% year over year.

Strong Organic Revenues

Total sales in the quarter improved 2% year over year to $17.22 billion. Foreign exchange hurt revenue growth by 1%, lower than management’s expectation of 2%. Revenues also marginally beat the Zacks Consensus Estimate of $17.10 billion.

Excluding these factors, revenues increased 3.1% on an organic basis. Strong global snacks and substantial sales gain in developing/emerging markets offset softer beverage volumes in Americas and Europe. Organic revenues grew 8% in developing/emerging markets.

Pepsi witnessed an effective net pricing gain of 3% in the quarter, same as in the past quarter. Volumes were flat in the quarter, slightly less than 0.5% in the last quarter.

Organic snacks and beverage volumes grew 1% each in the quarter.

Organic volumes increased 2% in the Frito-Lay North America snacks segment, but declined in the other American snacks businesses – 2.5% in Latin America Foods and 3% in Quaker Foods. Organic snacks volumes grew 2% in Europe and 11% in developing and emerging markets.

With regard to beverages, Pepsi’s American and European beverage volumes softened while developing/emerging market volumes improved from the last quarter.

Organic beverage volumes declined 2% in Europe and increased 3% in developing/emerging countries.

In the Americas, beverage volumes were flat, declining from a 0.5% increase in the last quarter. While non-carbonated beverages volume grew slightly in the quarter, carbonated soft drinks (CSD) once again declined due to category headwinds.

Amid growing health and wellness consciousness, consumers have become particularly wary about the use of artificial sweeteners and high sugar content in soft drinks due to the associated obesity concerns. This is affecting CSD sales of Pepsi as well as other soft-drink producers like The Coca-Cola Company (KO) and Dr Pepper Snapple Group (DPS).

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

Margins Improve

Core gross margins improved 46 basis points (bps) in the quarter helped by strong pricing, effective revenue management strategies and productivity gains.

Core constant currency operating profit improved 5.5% to $2.95 billion helped by net gains associated with divestures. Core operating margins grew 47 bps as strong pricing, cost reductions and productivity gains offset higher operating costs.

2014 Outlook Raised

Management increased its previously provided earnings outlook for 2014 and maintained its sales growth projection.

Pepsi expects core constant currency earnings per share to increase 9% year over year, up from 8% expected earlier. 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.

The rate of commodity inflation is expected to be higher than in 2013. Commodity inflation is expected in the low single-digit range. Productivity savings – expected at $1 billion – would be used to offset headwinds from cost inflation and thereafter reinvested in the business.

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

Pepsi carries a Zacks Rank #3 (Hold). A better-ranked beverage maker is Monster Beverage Corporation (MNST) with a Zacks Rank #2 (Buy).

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