Revenue management strategies and productivity gains strengthen Q3 earnings
Food and beverage heavyweight PepsiCo Inc. (NYSE: PEP) announced its Q3 FY16 financial results on September 29th, 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: 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. Read more about PepsiCo’s financial results below.
Q3 FY16 financial highlights
PepsiCo’s Q3 FY16 net revenues declined 1.9% to $16.03 billion from $16.33 billion a year earlier. Weaker foreign currencies and the Venezuelan deconsolidation each had a negative impact of 3 percentage points during the reporting quarter. Organic revenue, which excludes the impacts of foreign exchange translation and structural changes, grew 4.2%.
Organic revenue rose 8% in developing and emerging markets after excluding currency swings, and included an 11% growth in China and Mexico, while revenue rose 7% in Russia. The Company generates nearly half its sales from the overseas markets.
PepsiCo’s Q3 FY16 reported gross margin expanded 40 basis points and reported operating margin expanded 895 basis points. Reported operating margin expansion in the current year benefited from the 2015 Venezuela impairment charges. Moreover, core gross margin expanded 50 basis points and core operating margin expanded 30 basis points during the reporting quarter. Reported and core operating margin expansion reflect the implementation of effective revenue management strategies and productivity gains, partially offset by a 65-basis-point increase in advertising and marketing expense as a percentage of sales.
Reported operating profit jumped 99% while core constant currency operating profit rose 2%. The Venezuela impairment charges and the Venezuela deconsolidation had a net 91-percentage-point favorable impact on reported operating profit growth and the Venezuela deconsolidation had a 4-percentage-point unfavorable impact on core operating profit growth. PepsiCo’s gross operating margins expanded for the 15th straight quarter, putting it on track to book at least $1 billion in productivity gains in FY16 as part of a five-year, $5 billion cost-cutting plan.
As a result, PepsiCo’s Q3 FY16 profit more than tripled to $1.99 billion from $533 million a year earlier. Reported EPS surged 282% to $1.37 versus the prior year period, reflecting the impact of the 2015 Venezuela impairment charges. Foreign exchange translation negatively impacted reported EPS by 3 percentage points. Core EPS was $1.40, an increase of 4%. Excluding the impact of foreign exchange translation, core constant currency EPS increased 7%.
The 2015 Venezuela impairment charges and the Venezuela deconsolidation had a net 260- percentage-point favorable impact on reported EPS growth and the Venezuela deconsolidation had a 5-percentage-point unfavorable impact on core EPS growth. PepsiCo’s cash flow provided by operating activities was $3.7 billion.
Frito-Lay North America (FLNA): This segment benefitted by productivity gains and lower raw material costs, partially offset by operating cost inflation, higher advertising and marketing expenses and the impact of incremental investments during the reporting quarter.
Quaker Foods North America (QFNA): This segment was negatively impacted by higher advertising and marketing expenses, operating cost inflation and the impact of incremental investments, partially offset by productivity gains and lower raw material costs. The impact of ceasing the operations of PepsiCo’s dairy joint venture benefited operating profit performance by 3 percentage points during the reporting quarter.
North America Beverages (NAB): This segment was benefitted by productivity gains and lower raw material costs. These gains were partially offset by operating cost inflation, a pension-related settlement in the prior year (5 percentage points) and higher advertising and marketing expenses during the reporting quarter.
Latin America: This segment was benefitted by the 2015 Venezuela impairment charges and productivity gains. These gains were partially offset by operating cost inflation, the impact of the Venezuela deconsolidation, higher raw material costs, higher advertising and marketing expenses, adverse foreign exchange translation, and incremental investments.
Europe Sub-Saharan Africa (ESSA): This segment was negatively impacted by higher raw material costs, operating cost inflation, adverse foreign exchange translation, higher advertising and marketing expenses, and incremental investments. These costs were partially offset by productivity gains.
Asia, Middle East and North Africa (AMENA): This segment was benefitted by a prior-year charge related to a transaction with Tingyi-Asahi Beverages and productivity gains. Additionally, the impacts of a prior-year impairment charge associated with a joint venture in the Middle East and contract termination charge positively contributed to operating profit growth by 10 percentage points and 4.5 percentage points, respectively. These impacts were partially offset by higher advertising and marketing expenses and operating cost inflation during the reporting quarter.
Contribution to retail growth: During Q3 FY16, PepsiCo once again emerged as the largest contributor to retail food and beverage sales growth in the U.S., its largest market. PepsiCo generated approximately 37% of all food and beverage retail sales growth, significantly higher than its food and beverage dollar share position of less than 10%. The Company also generated more retail sales growth than all other $5 billion plus food and beverage manufacturers combined during the reporting quarter.
Productivity savings: PepsiCo is on track to deliver $1 billion in productivity savings in FY16 and on track to deliver $7 billion in free cash flow excluding certain items.
Performance with Purpose updates: On account of growing consumer backlash in regards to more healthy food and beverage, PepsiCo has transformed its product portfolio with a particular focus on reducing sodium, saturated fats, and added sugars. As compared to 2006, PepsiCo has reduced the average sodium in its food products by 11% per serving and removed more than 2300 metric tons of sodium from key global food brands in key countries. PepsiCo has also reduced the average amount of saturated fat per serving by more than 15% in key global brands in a number of major markets including the U.S., the U.K., China and Turkey. PepsiCo is also trying to reduce added sugars in its beverages through reformulation.
PepsiCo has adopted new technologies and processes that have steadily reduced its water use by unit of production and has implemented integrated water management in water stressed and water scarce areas. As a result, PepsiCo is using approximately 25% lesser water per unit of production.
Focus on innovation: PepsiCo recently launched Quaker Super Goodness porridge sachets in the U.K. made with whole-grain oats, quinoa, barley, and flax seed. It also introduced Carrot Pineapple Mango Tropicana Farm Stand in the U.S. made with 100% fruit and vegetable juices and no added sugar.
PepsiCo also expanded the Sabra brand of hummus and range of authentic products that include guacamole, salsa, baba ghanoush, and Greek yogurts dips and spreads. Sabra now generates approximately $800 million in estimated annual retail sales in the U.S. and is well on its way to becoming a $1 billion brand.
PepsiCo’s Naked super premium fruit and vegetable juices and coconut waters, which contain all-natural ingredients and no added sugars or preservatives, was recently extended with the introduction of Naked cold pressed juices.
PepsiCo is elevating its Pure Leaf Tea brand, which has grown to more than $650 million in estimated annual retail sales, since its launch in 2012, into a super premium line under the Tea House collection.
Spurred by the success of Baked Lays, PepsiCo has launched Baked Doritos, Baked Tostitos, and Baked Cheetos in nine international markets.
The company has also recently launched Stubborn Soda, a new generation of premium crafted sparkling beverage that is just 90 to 100 calories per 12 ounces and is made with fair trade certified cane sugar and Stevia with no high fructose corn syrup.
Guidance for FY16
Moving ahead, PepsiCo has upped its FY16 profit outlook after revenue surged in key overseas markets like China and as the U.S. beverage business picked up steam in Q3 FY16. The Company now expects adjusted EPS to grow 10% instead of the earlier projection of 9%, the second straight quarter that it has raised guidance as a cost-cutting push also helped lift its bottom-line. PepsiCo now expects FY16 EPS to rise to $4.78 from $4.57 last year, up from its July estimate of $4.71. It forecasts a negative impact of 2% from the deconsolidation of Venezuelan operations and a negative impact of 3% from foreign exchange. It also expects to return $7 billion to shareholders in FY16 through dividends of $4 billion and share buybacks of $3 billion.
PepsiCo’s stock stood at $108.25, slipping 0.48%, at the close on Monday, October 3rd, 2016, having vacillated between an intraday high of $108.83 and a low of $107.47 during the session. The stock’s trading volume was at 4,534,304 for the day. The Company’s market cap was at $155.66 billion as of Monday’s close.