PepsiCo (PEP) reported strong second-quarter results backed by 4.2% organic (adjusted for structural changes and foreign exchange translation) growth in consolidated net revenues and a core EPS growth of 17% y-o-y [Core EPS excludes the impact of commodity mark-to-market and other non-recurring charges]. The company’s core operating margins improved by 120 basis points y-o-y, primarily due to higher net pricing and savings from its ongoing productivity improvement program.
PepsiCo’s Americas Foods division posted a strong 6% organic revenue growth on higher sales volume in North America and better pricing in Latin America. However, the company’s Americas beverage unit posted a 1% decline in organic net revenue as lower volumes more that offset higher net pricing [PepsiCo Reports Second Quarter 2013 Results, pepsico.com].
According to our estimates, Frito-Lay North America is the most valuable division of PepsiCo and makes up more than one-third of our valuation estimate for the company. During the second quarter, Frito-Lay’s organic net revenue increased 4.5% y-o-y driven by 3% organic volume growth and 2 point benefit from effective net pricing. Strong revenue growth in the category backed by both higher volume as well as better pricing reinforces the company’s leading market position in the North America snacks market.
PepsiCo already sells more brands in the segment than any other player occupying majority of shelf space in the retail outlets [Pepsi to America: Thank You for Snacking, businessweek.com]. The company’s leading snacks business was also able to expand core-operating margins by 40 basis points despite higher marketing and advertising expense. This further bolsters our faith in the division’s capability to more than offset the company’s growing concerns in the beverage category.
Americas Beverages Continue To Drag
PepsiCo’s Americas beverage operations posted a 1% decline in organic net revenue for the second quarter as lower volumes more than offset higher net pricing. The division reported lower volumes in both carbonated as well as non-carbonated beverage categories in North America. However, the company was able to post positive earnings growth from the division as higher pricing and productivity gains helped in expanding margins.
PepsiCo played down the decline in beverage sales volume by pointing to higher value creation through pricing and its innovation strategy. We believe that while the strategy may work well for the company in some still beverage categories like still beverages where it maintains premium brands, like Gatorade, it may have to face the heat from leading brands in the sparkling category.
Moreover, sacrificing volume share in order to gain value share is a risky long term strategy and would only work in the long run if the company is able to invest these proceeds into higher growth offerings. However, there are inherent risks associated with this strategy as depending on new launches requires investment and sales may not ultimately live up to expectations after its launched. So we believe investors should continue to monitor the beverage volumes and pricing strategy going forward.
We currently have $77 price estimate for PepsiCo, which will soon be updated based on the second quarter earnings announcement.
Disclosure: No positions