PepsiCo: Investing Beyond Next Quarter

Oct. 7.10 | About: PepsiCo Inc. (PEP)

It is amazing how the market will interpret an earnings release five minutes after it hits the wire without taking the time to sit down and listen to what management has to say about the business, the environment, and the future of the company. As an owner in any corporation, it helps to learn about the brands and the long-term direction/vision of the companies that you are following so your research and analysis extends beyond the numbers. PepsiCo’s (NYSE:PEP) earnings release and subsequent decline on October 7th is a good example of why you shouldn’t simply follow EPS and revenue guidance from analysts.

As of writing, PepsiCo is down $2.59/share, or 3.8%; that is equal to more than $4B worth of market capitalization, gone in the amount of time that it takes to listen to the call (see earnings call transcript). After earnings came out, Wall Street pushed PEP lower, mostly due to full year earnings guidance. As executives have been saying since June, the company expected 11-13% EPS growth for the year. However, when PEP released Q3 earnings, the guidance for the year was tightened to 11-12%. CEO Indra Nooyi continually said to analysts that this is not a change of guidance, only a tightening. As she noted, “when we talk about 11-13, you [analysts] assume we mean 13, when we mean 11-13”. Naturally, most of your analysts have trouble looking beyond next quarter, so the topic of the guidance continued to be brought up again and again on the call.

CFO Hugh Johnson’s response to one of the questions about the guidance tightening makes the 3% plus decline for the day seem comical (from a long term investors perspective). The analyst was wondering “what businesses or regions are not delivering the level of earnings that they were expecting back in July?” Hugh Johnson’s response was exactly what long term investors like to hear:

I really question that characterization of anything not delivering as we expected to be perfectly honest with you… What we’ve really talked about here is much more geared towards making investments in good opportunities in the marketplace, some of which are nearer-in in nature, some of which are a little bit further out in nature, but all of which are geared towards building the business and all of which have good returns on them.

This isn’t about weakness; it’s about opportunity. Some of the areas where spend/investments have increased include China, India, continued brand development, and innovative research (announced the start of the Global Nutrition Group which will be based in Chicago and run by Chief Scientific Officer Mehmood Khan). To no surprise, the analyst didn’t seem too concerned with PepsiCo’s Power of One initiative and how it has developed over the past year.

When we look through the numbers, it is clear that PepsiCo is developing the core fundamentals of the business. PepsiCo had six billion-dollar brands in 1990; they have 19 in the portfolio today. Key executives have maintained this focus on long term brand development and core growth while also giving back to shareholders each and every quarter. During Q3, for example, the company bought back $1.1 billion worth of stock, and paid $767 million in dividends. With the bottler acquisitions and the resulting synergies that will lead to $400M in annual savings starting in 2012, I believe that PepsiCo will continue to reward investors for their long term commitment for many years to come.

For the time being, we are still in the woods. The macroeconomy remains tough in the U.S. and Western Europe, but is growing slightly around the rest of the world. PepsiCo, as noted by Indra Nooyi in the closing remarks, is “prepared and confident”. Long term investors should feel exactly the same way.

Disclosure: Long PEP