PepsiCo: A Look Ahead to June 2009 Quarterly Results

 |  Includes: PAS, PBG, PEP
by: Neil Carvin

The GCFR Overall Gauge of PepsiCo (NYSE:PEP) slipped from 52 of the 100 possible points to 49 in the 12 weeks that ended on 21 March 2009. This period was the first quarter of the company's fiscal 2009. Our original and updated analysis reports explained this result in some detail.

PepsiCo earned $0.72 per share in the first quarter, up from $0.70 in the same segment of 2008. Net Income was down 1 percent, but the $4.7 billion spent repurchasing company stock reduced the number of shares outstanding. (We brooded about the massive increase in debt that occurred simultaneously, but that is a different story.) Quarterly Revenue fell, albeit slightly, hurt by the depreciation of various currencies relative to the U.S. dollar. However, an improved Gross Margin enabled Operating Income to eke out a small increase. Higher interest payments (tsk, tsk) were more or less balanced by a lower income tax rate.

We have now modeled PepsiCo's Income Statement for fiscal 2009's second quarter, which will end on 13 June. The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce on 22 July. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

PepsiCo, Inc., is a leading global purveyor of beverages and snacks. The company is well regarded for good management, steady growth, significant international exposure, and the defensive characteristics of the food industry. While famously locked in a battle with Coca-Cola (NYSE:KO) for the soft-drink market, PepsiCo's snack food business diversifies the company. The Frito-Lay North America division takes in more Revenue, and it contributes more to Operating Profit, than the PepsiCo Americas Beverages unit.

Food and Beverage businesses are relatively less affected by economic slumps, but they are not immune. Consumers have also shown an increased preference for non-carbonated beverages. One aspect of PepsiCo's response to this environment has been to cut recurring costs through workforce reductions and plant closures. This plan, under the banner "Productivity for Growth," led to pretax charges in the fourth quarter of 2008 totaling $543 million. Additional related charges of $32 to $57 million are expected in fiscal 2009.

In April 2009, PepsiCo offered approximately $6 billion to buy the shares it does not already own in Pepsi Bottling Group, Inc. (PBG) and PepsiAmericas, Inc., (PAS), which are its two largest bottlers. At the time the offer was made, PepsiCo owned about 33 percent of Pepsi Bottling Group and 43 percent of PepsiAmericas. The WSJ reported:

Chief Executive Indra Nooyi said in an interview that Pepsi wants to take over its big U.S. bottlers so it can eliminate more than $200 million annually in duplicative costs and retool a bottling system designed for sodas for a new era when teas, waters and juices are increasingly dominating Pepsi's beverage portfolio.

Both bottlers rejected the bids. PBG, which has on its own been buying other bottlers, labeled PepsiCo's offer "grossly inadequate." PepsiCo responded by announced it would remain "disciplined."

For 2009, PepsiCo shuffled some international businesses from one reporting segment to another. The fourth quarter of 2008 was the first to include financial results for the recently acquired potato-chip maker Marbo in Serbia and the juice-maker Lebedyansky in Russia. The latter was a joint acquisition with PBG.

Now, we are ready to look ahead.

PepsiCo's press release in April announcing its first quarter results reaffirmed the guidance for 2009 that had been given in February:

2009 Guidance

The company is reaffirming its full-year 2009 guidance for both net revenue and core EPS of mid- to high-single-digit constant currency growth. The company estimates that foreign exchange, at current spot rates, would have a high-single-digit percentage point adverse impact to our full-year constant currency core EPS. The company’s 2008 core EPS was $3.68.

Excluding the impact of its $1 billion discretionary pension contribution (approximately $640 million after-tax cash impact), cash from operating activities is expected to be about $7 billion. The company expects to invest up to $2.1 billion in net capital spending.

The company’s 2009 guidance does not include the impact of the proposed transactions with The Pepsi Bottling Group, Inc. and PepsiAmericas, Inc., which were also announced today.

To establish a Revenue target for the second quarter, we start with the company's guidance for a Revenue percentage growth rate for the year, on a constant currency basis, in the "mid- to high-single digits." This is suggestive of a range between 6 and 9 percent.

The effect of foreign exchange on Revenue cannot be ignored because PepsiCo's operations outside of the U.S. generated 48 percent of Revenue in 2008. PepsiCo, of course, operates in many different currencies. The company also takes certain steps to reduce its exposure to exchange rate changes.

We can't possibly model this complexity, so we will make the crude assumption that the Euro can stand as a proxy for the various currencies handled by the non-U.S. half of PepsiCo. Historical exchange rate data from OANDA indicates the dollar bought, on average, 0.63947 Euro during the twelve weeks that comprised PepsiCo's second quarter of 2008. In this year's equivalent quarter to date, the dollar has been worth 16 percent more because it has been convertible, on average, to 0.74194 Euro.

Since only half of PepsiCo's business is outside the U.S., we will assume the stronger dollar will cut 8 percent from second quarter Revenue.

Given the expectation for constant-currency Revenue growth of 6 to 9 percent, PepsiCo's overall Revenue growth could be minus 2 to plus 1 percent. We'll pick the average, minus 0.5 percent, as our target. Therefore, our estimate for the second 12 weeks of 2009 is 0.995 * $10.945 billion = $10.89 billion.

In the first quarter, PepsiCo's Gross Margin increased from 54.0 percent to 54.7 percent of Revenue. For the second quarter, we will look for another 0.7 percent rise off of last year's 53.6 percent. In other words, we're projecting the Cost of Goods Sold to be (1 - 0.543) * $10.89 billion = $5.0 billion.

In the second fiscal quarter of the last five years, SG&A expenses averaged 34.8 percent of Revenue, but the ratio has clearly been decreasing. For our second quarter target, we will round down to 34 percent. Therefore, our assumption for these costs is 0.34 * $10.89 billion = $3.7 billion.

We'll assume a $15 million charge for amortization of intangible assets. This estimate is based on quarterly charges in the last couple of years.

These assumptions would lead to Operating Income, as we define it, of $2.2 billion. If achieved, this figure would surpass the equivalent amount in the year-earlier quarter by less than one percent. Note that this estimate does not include Productivity for Growth, nor mark-to-market commodity hedge costs.

Bottler equity income will probably be down from last year's hefty amount because it is unlikely PepsiCo profited by selling shares in its bottling operations, as it had in the past. We will assume equity income that matches the first quarter's $25 million.

A $110 million charge for net Interest Expense seems reasonable given recent history. This would result in pre-tax income of $2.1 billion.

We're using a 26 percent effective income tax rate, which is between the first-quarter rate and the full-year guidance. This rate would result in a tax provision of $550 million. The rate can be volatile from quarter to quarter.

Rolling up these figures, we're looking for Net Income of $1.56 billion ($1.00/share). In last year's second quarter, PepsiCo earned $1.7 billion ($1.05/share).

Click here to see a full-sized, normalized depiction of the projected results next to PepsiCo's quarterly Income Statements for the last couple of years. Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats. The standardization facilitates cross-company comparisons.

Full disclosure: Long PEP at time of writing.