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Pepsi Beats on Q1 Earnings, Misses Sales; Keeps 2016 View

PepsiCo, Inc. PEP began 2016 on a mixed note as earnings beat the Zacks Consensus Estimate in the first quarter while sales fell shy of expectations.

Moreover, this Purchase, NY-based food/beverage giant kept its previously issued 2016 outlook intact.

Earnings Beat

Pepsi’s first-quarter core earnings per share of 89 cents beat the Zacks Consensus Estimate of 81 cents by 9.9%.

Earnings rose 7% year over year despite currency headwinds eroding sales.

With around half of its revenues coming from outside the U.S., Pepsi’s sales and profits are being affected by significant currency headwinds due to the recent weakening of many foreign currencies against the U.S. dollar.

Currency hurt earnings by 4% since a strong dollar lowered the value of Pepsi’s overseas sales.

In constant currency terms, adjusted earnings grew 11% as strong margins made up for the slightly softer organic revenue growth and higher advertising costs.

Core earnings mainly exclude an impairment charge related to Pepsi’s 5% indirect equity interest in Chinese beverage company Tingyi-Asahi Beverages. Including this item, reported earnings came in at 64 cents, down 21% year over year.

Since the fourth quarter of 2015, Pepsi is no longer consolidating the results of its Venezuelan operations in its financial statements.

 

Sales Discussion

Total sales declined 3% year over year to $11.86 billion largely due to currency headwinds. Foreign exchange (Fx) hurt revenue growth by 4.5% while Venezuela deconsolidation had a 2% negative impact on sales. Revenues marginally missed the Zacks Consensus Estimate of $11.90 billion by 0.3%.

Excluding the impact of Fx and Venezuela deconsolidation, revenues increased 3.5% on an organic basis. However, organic sales growth was slightly softer than the 4% rise recorded in the previous quarter as improved volumes were partially offset by softer pricing gains.

While performance remained strong in North America, the quarter saw a significant pickup in organic volumes in some international markets.

Pepsi witnessed an effective net pricing gain of 2%, less than 3% in the past quarter. The inflation-based pricing benefits in Venezuela are no longer available as Pepsi does not include results from its Venezuelan subsidiaries from the last quarter, which explains softer net pricing benefits.

Volumes grew 2%, better than 1% in the previous quarter. Both organic snacks and beverage volumes improved from the last quarter, growing 1.5% and 3%, respectively. Significant improvement in both snacks and beverage volumes in Asia, Middle East and North Africa (AMENA) and Latin American segments led to the overall improvement in volumes in the quarter.

Organic volumes grew 1% in the Frito-Lay segment, the same as last quarter. Organic volumes declined 2% in Quaker Foods, another American snacks business, same as the prior quarter. Organic snacks volumes rose 3% in the Latin America segment and 6% in AMENA, both better than last quarter. Organic snacks volume rose 1% in the Europe Sub-Saharan Africa (ESSA) segment, the same as last quarter.

Organic beverage volumes rose 2% in ESSA, 3% in Latin America and 5% in AMENA, all better than last quarter. Beverage volumes grew 1% in the North Americas Beverages (NAB) segment, the same as last quarter.

In order to revitalize sales of its carbonated beverages, which are suffering from their high calorie content, the company launched craft soft drinks called Stubborn Soda in fountains this year. Stubborn Soda contains fair trade certified cane sugar and natural flavors, and are devoid of high fructose corn syrup. Also, an aspartame-free Diet Pepsi was launched in Aug 2015 to cater to the growing demand for food/drinks without artificial sweeteners. Pepsi is also testing cola product variations using evolutionary natural sweeteners in various markets. We believe that Pepsi’s marketing initiatives and innovative product launches are beginning to benefit its beverage sales.

Margins Rise

Core gross margins improved 130 basis points (bps) backed by higher pricing, effective revenue management strategies and productivity gains. Lower costs of key raw materials also benefited margins.

Core constant currency operating profit rose 12% to $1.98 billion. Core operating margins rose 165 bps as higher gross margin gains and cost reductions offset higher marketing costs. Advertising and marketing expenses, as a percentage of sales, rose 65 bps in the first quarter.

The core effective tax rate was 24.7%, higher than 23% a year ago.

2016 Outlook Maintained

Pepsi maintained its previously issued guidance for 2016.

Pepsi expects core constant currency earnings per share (excluding Venezuela deconsolidation) to increase 8%. Currency and Venezuela deconsolidation are likely to hurt earnings per share by 4% and 2%, respectively.

Including the headwinds from Venezuela deconsolidation and currency volatility, earnings are expected to increase 2% to $4.66 per share.

Excluding headwinds from currency and structural changes, organic revenues are expected to rise 4%, excluding the impact of an extra week this year. Currency is projected to hurt revenues by 4%, while the 53rd week is expected to add 1% to sales growth.

Commodity inflation is expected in the low single-digit range (including the transaction-related Fx impact) compared to the previous expectation of low-to-mid single digit. Productivity savings are anticipated to be approximately $1 billion.

Also, management plans to return $7 billion through dividends and share repurchases.

The core tax rate is expected to be roughly the same as the 2015 rate of 24.3%. Interest expenses are however likely to be higher than the year-ago level due to increased debt balances and higher interest rates.

Pepsi carries a Zacks Rank #3 (Hold). Some better-ranked beverage stocks are Primo Water Corporation PRMW,Coca-Cola Enterprises, Inc. CCE and Cott Corporation COT. While Primo Water enjoys a Zacks Rank #1 (Strong Buy), Coca-Cola Enterprises and Cott Corporation have a Zacks Rank #2 (Buy).

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COCA-COLA ENTRP (CCE): Free Stock Analysis Report
 
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