PepsiCo Beats Expectations in Q2, Ups FY16 Guidance

Revenue management strategies and productivity gains strengthen Q2 earnings

Source: Company's Website
Source: Company’s Website

Food and beverage heavyweight PepsiCo Inc. (NYSE: PEP) announced its Q2 FY16 financial results on July 7th, 2016. The Purchase, New York-based Company, through its operations, bottlers, contract manufacturers and other third parties, market, distribute, and sell a range of beverages, foods, and snacks in over 200 countries and territories. The Company operates through six segments, namely, Frito-Lay North America (FLNA); Quaker Foods North America (QFNA); North America Beverages (NAB); Latin America; Europe Sub-Saharan Africa (ESSA), and Asia, Middle East and North Africa (AMENA). Its popular brands include Aquafina, Aquafina Flavorsplash, Aunt Jemima, Cheetos, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Pepsi, Frito-Lay, Fritos, Mountain Dew, and Tropicana. The Coca-Cola Co. (NYSE: KO), Dr. Pepper Snapple Group Inc. (NYSE: DPS), Kellogg Company (NYSE: K), Mondelez International Inc. (NASDAQ: MDLZ), Monster Beverage Corp. (NASDAQ: MNST), Nestle S.A., Red Bull GmbH, and Snyder’s-Lance Inc. (NASDAQ: LNCE) are the main competitors of Pepsico. Read more about PepsiCo’s financial results below.

Q2 FY16 financial highlights

PepsiCo’s Q2 FY16 net revenues fell 3% to $15.39 billion from $15.92 billion in the previous year quarter reflecting a volatile global macro environment for the Company. Foreign exchange translation had an unfavorable impact of 4% on the Company’s net revenue, while the Venezuela deconsolidation dented net revenue by 2.5% during Q2 FY16. Excluding the impacts of foreign exchange translation and structural changes, organic revenue grew by 3.3% during the quarter under review.

Source: Company's Website
Source: Company’s Website

Reported gross margin expanded 115 basis points, while reported operating margin expanded 105 basis points. Core gross margin expanded 75 basis points and core operating margin expanded 80 basis points. Reported and core margin expansion reflects the effective revenue management strategies and productivity gains, and was partially offset by advertising and marketing expense as a percentage of sales.

Reported operating profit increased 2% and core constant currency operating profit increased 4%. The deconsolidation of our Venezuela operations had a 2.5% unfavorable impact on both reported and core operating profit.

P3During Q2 FY16, PepsiCo reported a 1% rise in net income to $2.01 billion compared to $1.98 billion in the prior-year period, driven by a 115 basis points expansion in gross margin. Reported EPS advanced 4% to $1.38 a share from $1.33 a share in the year-ago quarter, while core earnings grew 2% to $1.35 a share. On a constant currency basis, PepsiCo’s core earnings would have advanced 6%. In Q2 FY16, cash flow provided by operating activities was $2.8 billion.

Product launches

Source: Company's Website

PepsiCo launched a new line of flavored sparkling water called Aquafina Sparkling under its Aquafina™ brand on April 19th, 2016. Aquafina Sparkling is available in three fruit flavors: Black Cherry Dragonfruit, Lemon Lime, and Orange Grapefruit. Each single-serve, 12-ounce can contains just 10 calories. The launch comes in the wake of consumers’ increasingly shunning soda in favor of healthier beverages such as instant fruit juices, fruit blends, and flavored waters.

Other highlights

PepsiCo has announced on June 27th, 2016, that it will bring back Diet Pepsi with aspartame in September 2016. In April 2015, the Company has stated that it would remove aspartame from Diet Pepsi after consumer surveys showed that the zero-calorie sweetener was the main reason people were shunning diet cola. Consequently, PepsiCo launched its new Diet Pepsi with sucralose in August 2015. However, since the launch of its new Diet Pepsi, the Company again faced consumer backlash from the diehard diet soda lovers who found the sucralose-induced soda unpalatable, forcing PepsiCo to bring back its Diet Pepsi with aspartame. PepsiCo will continue its production of Diet Pepsi with sucralose even with the reintroduction of the aspartame version.

Guidance for FY16

Moving ahead, PepsiCo has upped its guidance for FY16 despite fears that the global economy may contract amid a slowdown in China, recession in major markets such as Brazil and Russia, and uncertainty with the Brexit’s aftermath. PepsiCo now projects FY16 EPS at $4.71, higher than its previous guidance of $4.66 per share. The Company expects about 4% organic revenue growth and that foreign exchange transaction may impact its revenue by four percentage points.

P5It also expects to return $7 billion to shareholders in FY16 through dividends of $4 billion and share buybacks of $3 billion.

Stock Performance

P6PepsiCo’s stock stood at $108.27, inching up 0.73%, at the close on Friday, July 8th, 2016, having vacillated between an intraday high of $108.50 and a low of $107.32 during the session. The stock’s trading volume was at 6,013,697 for the day. The Company’s market cap was at $156.23 billion as of Friday’s close.

Industry outlook

The carbonated beverage industry is going through a major shift in recent years as consumers are increasingly avoiding both sugary drinks and artificially sweetened beverages that contain zero nutrition, excessive aspartame or caffeine, since these are said to increase diabetes and other health-related risks. As a result, beverage majors including PepsiCo, Coca-Cola, and Dr. Pepper Snapple are grappling with plunging sales and falling demand for their soda and diet soda drinks. The per capita soda consumption in the U.S. tumbled to a 30-year low in 2015, according to Beverage Digest and as reported by Bloomberg on June 17th, 2016.

Beverage companies went into a re-formulation frenzy to launched aspartame-free sodas and diet versions of their sugar-loaded beverages in August 2015. However, this effort only made their market share losses worse since consumers did not favor the taste of sucralose, the alternative used for aspartame. Hence, U.S. retail sales of Diet Pepsi fell 10.6% in terms of volume in Q1 FY16; the Company’s soda market share fell 0.4% to 4.1% in the period, according to industry tracker Beverage Digest and as reported by The Wall Street Journal on June 27th, 2016. Sales of Coca-Cola’s Diet Coke declined 5.7% over the same period, a huge loss for Coca-Cola since Diet Coke has a 7.4% soda-market share in the U.S. As a result, PepsiCo will market both versions of Diet Pepsi, with aspartame and sucralose, in the U.S. to give customers a broader choice.

Giving voice to the growing consumer backlash in regards to more healthy food and beverage, Philadelphia became the first major U.S. city to pass a tax on soft drinks on Thursday, June 16th, 2016, dealing a significant blow to the soft drinks industry. The City Council has approved a plan to add a 1.5-cents-per-ounce tax on soft drinks containing added sugar or artificial sweeteners. Drinks that will not be taxed are those that are more than 50% juice or milk.

Beverage companies will have to cater to the shift in the preference of health-conscious consumers who are embracing healthier beverages such as instant fruit juices, fruit blends, and flavored waters. In view of recent uproar from diehard consumers, these companies have to walk a thin line by not totally eliminating products from their pipelines to satisfy a new trend in consumption.

Lastly, beverage companies will likely face headwinds arising due to the lackluster economic performance of markets such as Brazil, China, Russia, and Europe. They would also have to contend with uncertainty about consumer spending in both U.S. and key international markets in 2016. Investors will be looking forward for this quarter’s readings to have a clue of the industry’s health.

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