PepsiCo's International Business Remains Strong

| About: PepsiCo Inc. (PEP)

Food and beverage giant PepsiCo (NYSE:PEP) reported mixed third-quarter results Wednesday morning. Revenue fell 5% year-over-year to $16.7 billion, which was a bit worse than consensus expectations. However, earnings on an adjusted basis fell only 4% to $1.20, which was a few cents better than consensus estimates.

After excluding some divestitures and refranchising agreements, organic revenue increased 5% year-over-year, driven by 1% volume growth and 4% pricing growth. The company's ability to generate cash continues to impress, as operating cash flow year-to-date registered $5.1 billion. We were also excited to see broad-based strength across its portfolio, especially internationally. For one, Latin American Foods revenues surged 13% on the back of strong pricing and volume gains. Though operating profit remained relatively flat, we think the brand's snack portfolio is performing extremely well, and it won't have to encounter obesity backlash for some time (in our view).

In a drastic departure from most other firms, Pepsi saw 7% year-over-year organic growth in Europe, driven mostly by strength in Russia and strong pricing. While European strength has been relatively ignored, 7% organic growth drastically outpaced the 1% we saw at Coca-Cola (NYSE:KO). Frito-Lay's reasonably priced and calorie-dense snacks could be resonating with cash-strapped Europeans. The Asia, Middle-East, and Africa (AMEA) region was also quite strong, with revenues growing at a 10% rate organically. High-single-digit beverage growth and double-digit snack growth drove the figure, resulting in 14% gains in constant currency operating profit.

Though some refranchising occurred, pushing down reported revenue in China, CEO Indra Nooyi sounded rather bullish with respect to the company's beverage partnership with Tingyi, which is giving the firm a tremendous competitive advantage via distribution. Given this partnership, as well as Pepsi's partnership with Yum! Brands (NYSE:YUM), we think the company could develop as the number one beverage option in China. We think India's beverage market tends to favor Pepsi as well, with beverage volume surging 23% during the quarter.

Pepsi's international beverage business is making gains in Asia, but it continues to trail Coca-Cola on the home turf. Organic revenue in Pepsi America remained flat, with 3% of price increases wiped out by a 3% decline in volumes. Though the firm promotes its relationship with 22 NFL teams as a potential catalyst, we think years of underinvestment in the domestic business have left the Pepsi name meaningfully lagging Coca-Cola. With Diet Coke and Coca-Cola Classic the top two beverages in the US, we think it will be difficult for the company to recover sparkling beverage market share.

Further, Gatorade, once the crown jewel of the Quaker Oats acquisition, continues to languish. Coke introduced calorie-free sports drink Powerade Zero a few years ago, and it priced the beverage attractively compared to Gatorade. The company continues to stuff channels with the drink, often priced below $1, and we think consumers have been incredibly receptive to both pricing and the health proposition. Gatorade has tried to reinvent itself as a sports supplement company, but that's mostly been a failure, in our view, since the space is saturated.

Frito-Lay North America grew 3% organically during the third quarter thanks to increased market share in the convenience store space and strong pricing trends. We think the firm's brand portfolio in snacks is resilient in light of generic competition, so the segment should remain strong, even if macro demand remains relatively weak.

Overall, we thought PepsiCo's quarter was decent, and we're optimistic about what we've seen in the firm's international business. Management reiterated its $4.40 per share earnings guidance for 2012, but we think shares remain fairly valued. For a read on how we derive the intrinsic value of PepsiCo, please click here. We think improvement in the US beverage business looks marginal at best, and we simply aren't very excited about the firm's total return prospects at current levels. We will not be adding the name to the portfolio of our Best Ideas Newsletter.

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.

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Tagged: , Processed & Packaged Goods, Earnings
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