PepsiCo Earnings Preview

| About: PepsiCo Inc. (PEP)

Before the opening bell on July 25, PepsiCo (PEP) is scheduled to release earnings for its second quarter of fiscal year 2012. The Street is expecting the food and beverage giant to report earnings of $1.10 per share on revenue of $16.59 billion. PepsiCo has surpassed the Street's earnings per share forecast in the past three quarters, but these quarters were far from blowout quarters. PEP has consistently trailed the Coca-Cola company (KO) over the past few quarters on the beverage side of the business. However, the food business for PEP (KO doesn't have a food business) continues to operate extremely well around the world. Europe Snack and Beverage volumes have remained strong. The following chart shows volume growth by segment over the past three quarters.

(Click to enlarge)

Volumes in Europe and AMEA (Asia, Middle East, and Africa) have remained strong, especially snack volumes as PEP has remained active on the acquisition front abroad. It is not all about volumes though; the current quarter is going to see considerable headwinds from commodity prices and currency. Commodities will continue to be a problem through the remainder of the year and into next year. The drought that is affecting the United States will have a domino effect across the country and the world. Food costs are expected to rise which will further eat into PEP's margins. Operating margins declined across each segment during the first quarter of 2012 and all but one during the fourth quarter of 2011. KO reported last week that its operating margins were pressured especially during in late May and June. I expect PEP's segment to see continued pressure, but it is going to be key to hear what management is doing to reverse the negative trend. The following chart shows operating margin by segment over the past three quarters.

(Click to enlarge)

Over the past few weeks, the company has made three significant announcements. First, the company increased its dividend approximately 4% to $0.5375 per share per quarter. The dividend is payable September 28, 2012, to shareholders of record on September 7, 2012. The second big announcement and perhaps the best news in my mind is that PEP will begin to sell dairy and yogurt products in the United States through a joint venture with German dairy company Theo Muller Group. The yogurt and dairy markets are booming in the United States and fits in nicely with PEP's "Good For You" slogan. The third item is that PEP is now sponsoring the halftime show for Super Bowl XLVII in New York City as well as the next few seasons. This is the apex of advertising, as the commercials are as interesting as many first quarters have been. However, this is definitely going to cost a pretty penny. General Motors (GM) backed out of advertising during this year's game stating that the cost was too high. The past two advertising gambles haven't really paid off in terms of a return on investment, but hopefully this will turn the tide.

During the quarter, PepsiCo reaffirmed its 2012 outlook, forecasting that adjusted net income would fall by 5%, with an incremental $500M in marketing spending during the year. Some of that marketing spending is certainly related to the Super Bowl, as the company announced that it reached a multi-year deal with the NFL to become the sponsor of the game's halftime show. Also, PEP lowered its currency guidance to negative 3% from negative 2% previously, which continues a trend among multinationals who are seeing their results hurt by the strength of the dollar and the weakness of the euro.

Despite higher commodity costs and increased marketing spend, estimates for the quarter haven't been adjusted down. The Street is modeling for earnings of $1.10 per share on revenue of $16.59 billion. My revenue forecasts are slightly higher at $16.71 billion; however, my models see a stronger headwind from currency and more operating margin pressure across the segments, namely Frito-Lay North America and Quaker Foods North America. As a result, my earnings per share estimates are for earnings of $1.07 per share.

KO is my favorite in the space as a result of the growth prospects overseas. PEP's beverage business is suffering in North America and many are beginning to mumble or a split of the company. CEO Indra Nooyi has been attempting to lay the foundation for solid growth moving forward, but few of her initiatives have panned out and the return on investment of many of these items is very low. I think we see strong volume growth overseas, particularly in AMEA snack and beverage; however, Pepsi America Beverages (PAB) will continue to suffer. I would not be buying PEP ahead of earnings tomorrow.

Disclosure: I am long KO.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Tagged: , Processed & Packaged Goods, Earnings
Problem with this article? Please tell us. Disagree with this article? .