Pepsi Remains Better Than Its Rival

Apr.28.14 | About: PepsiCo Inc. (PEP)

Summary

Top line growth was hidden under currency effect and structural changes which gave reported figures at unsatisfactory levels during the last quarter.

Complementary nature of snacks and volume increases make the segment an important inclusion in PepsiCo’s business model.

Bottom line savings together with PepsiCo’s diversified nature makes it a better investment than its rival.

The earnings season has started with many firms revealing their quarterly status this month. While some organizations have failed to deliver what analysts expected, Pepsi Co (NYSE:PEP) isn't one of them. The snack and beverage maker has recently been under the pressure from activist shareholder Nelson Peltz to spin off its snacks business from its North American beverage segment. But here in this article I will discuss some points that may prove why his suggestion may not be for the best of the company and its return generating potential.

First Quarter

Source: Presentation

PepsiCo's organic revenues, excluding the impact of currency translation and structural changes, rose 4%. The total figure of $12.62 billion was above the $12.43 billion expected by Wall Street according to Reuters but remained flat year over year. Special events were a material blow with currency bringing in a 3% headwind greater than structural change's 50 bps. Each operating segment had organic revenue growth in the quarter with snack posting the highest figure of 5%.

Although revenues from beverages declined they too grew organically (3%). Since organic growth is what really matters this was a positive improvement. This is because the carbonated soft drinks "CSD" market is in shrinking. Local sales of CSD decreased by 12% in the last 10 years from 10.1 billion cases in 2003 to 8.9 billion cases in 2013. Considering this fact alone, a positive internal growth driven sale while volume remained even is a result worthy of appreciation.

The reported gross margin increased 80 bps to 54.5%. However, revenue management strategies and productivity initiatives caused the core gross margin to increase by 40 bps. Core operating margins increased 50 basis points with core EPS following a 7% growth and rising to $ $0.83 in the period. If there hadn't been any currency fluctuations the figure would've been 300 bps higher than reported.

The company attained 3% of leverage due to lower interest expense, tax rate, and share repurchases. PepsiCo returned $2.1 billion to shareholders in the form of dividends and share repurchases reflecting a 47% increase than last year. All in all, the quarter brought improvements to returns for investors according to the industry standards. I say this because PepsiCo's biggest rival Coca Cola (NYSE:KO) saw a 4% decline in revenue last quarter. Its EPS also grew at a comparatively smaller rate than Pepsi's. While the dividend yield for both companies stands at a close 2.7% presently, it is the future offerings that distinguish one from the other. PepsiCo holds a diversified portfolio of snacks. Last quarter the company grew its snacks volume by 2%. This included products that ranged from snack foods such as Lays and Doritos to healthier options such as Quaker Oats. The balance and diversity of goods held by the company gives it the ability to manage through issues that arise in any specific product or area. Together, they provide a growth potential not offered by beverages alone.

Moreover, the research expenditure catered towards developing new products is proving successful for snacks. Since 2011, PepsiCo has increased its R&D by 25%. This doesn't deserve criticism since products launched from this research over the past three years make up 8% of total sales for the company.

This whole bundle is further strengthened by PepsiCo's growth off shore. The investments made to expand its presence in the developing and emerging markets are already paying off. Last quarter, D&E markets grew organic revenue by 9% following a 10% growth for the full year in 2013. The countries include India, Brazil, and Russia all of which have contributed high levels of growth.

An important factor investors should also consider is the complementary nature of PepsiCo's product offering. Consumers are likely to opt for snacks and a drink together. This gives it an added benefit. If everything fails, Pepsi knows it can rely on its portfolio of brands. For Coca Cola, there will be a shortage of options.

Speaking of bottom line measures, Pepsi expects to deliver $1 billion in productivity savings for the year. The table above showed that the company's core gross margin improved. . The company will begin its next major productivity program targeting $5 billion over five years beginning in 2015 which will focus on increasing automation, deploying more shared services, and optimizing its manufacturing capabilities together with the go-to-market system.

Bottom Line

I'm not saying Coca Cola is a bad company but given the prospects on a comparative basis it looks like PepsiCo is a safer bet when the beverage market seems to be shrinking every year. Even with currency headwinds of 3% expected for full year 2014 PepsiCo says it will deliver $8.7 billion through dividends and share repurchases in 2014. This will be a 35% increase year-over-year. Last quarter, the annual dividend rate grew 15% which was not surprising given then company's long history of raising its dividend rate for the past 41st years. All of these prospects translate into a good upside for the company. Therefore, I give PepsiCo a buy rating.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.