PepsiCo, Inc. (PEP) continued the momentum witnessed in the first quarter into the second. The food/beverage giant beat the Zacks Consensus Estimate for both earnings and revenues gaining largely from lower-than-expected currency headwinds and a sequential improvement in beverage volumes.
Moreover, the Zacks Rank #2 (Buy) company raised its earnings guidance for the year based on its strong year-to-date performance and an optimistic outlook for the rest of the year. Pepsi’s shares rose 2.0% in pre-market trading. In fact, its share price has gone up almost 10% year-to-date.
Pepsi’s second-quarter 2014 core earnings per share of $1.32 comfortably beat the Zacks Consensus Estimate of $1.23 by 7.3%. Earnings increased 1% year over year driven by strong organic revenue gains and solid margins. Currency hurt fourth-quarter earnings by 2.0%, significantly lower than management’s expectations of 5%. In constant currency terms, adjusted earnings grew 3%.
Despite difficult consumer spending environment and higher taxes, lower-than-expected currency headwinds, better execution and productivity gains boosted profits in the quarter.
Core earnings exclude the impact of restructuring and impairment charges and mark-to-market gains on commodity hedges. Including these factors, reported earnings per share were $1.29, up 1.0% year over year.
Top-Line and Volume Growth
Total sales in the quarter improved 0.5 year over year to $16.89 billion. Structural changes, mainly beverage re-franchising transaction in Vietnam, pulled down revenues slightly. Foreign exchange hurt revenue growth by 3.0%, lower than management’s expectation of 4%. Revenues were in line with the Zacks Consensus Estimate.
Excluding these factors, revenues increased 3.6% on an organic basis. Improved beverage volumes, strong Frito-Lay snacks performance in the Americas, and substantial sales gain in developing/emerging market offset weakness in Mexico and slowdown in Europe.
Pepsi witnessed an effective net pricing gain of 3% in the quarter, same as in the past four quarters. Volumes increased 0.5% in the quarter, slightly less than 1% in the last quarter.
Organic snacks and beverage volumes grew 1% each in the quarter.
Organic volume of the American snacks segment was flat, slowing down from 1% seen in the last quarter. While volumes remained strong in the Frito-Lay North America segment, it declined in the Latin American snacks business due to weak revenues in Mexico. Higher food and beverage taxes in Mexico once again hurt revenues in the quarter. Organic snacks volumes grew 1% in Europe and 7% in developing and emerging markets.
As regards beverages, while Pepsi’s American and developing/emerging market volumes improved, European volumes declined from the last quarter.
Organic beverage volumes increased 1.0% in Europe and 2% in developing/emerging countries.
In the Americas, beverage volumes improved 0.5%, better than flat growth in the last quarter — a sequential improvement as witnessed by peer, The Coca-Cola Company (KO) which reported earlier this week. Also, the company gained market share in the liquid refreshment beverage (LRB) category in the quarter. However, while non-carbonated beverages volume grew in the quarter, carbonated soft drinks (CSD) remained a weak spot due to category headwinds.
Growing health and wellness consciousness, vigilance among consumers about the use of artificial sweeteners, high sugar content and related obesity concerns are affecting the demand for CSD and thereby hurting sales of Pepsi as well as other soft drink makers like The Coca-Cola Company and Dr Pepper Snapple Group, Inc. (DPS).
Pepsi has increased marketing investments and is driving package and product innovation to boost its American beverage business.
Margins Improve
Despite higher commodity costs, core gross margins improved 60 basis points (bps) in the quarter helped by effective revenue management strategies and productivity gains. Core constant currency operating profit (including gain Vietnam re-franchising) improved 3.0% to $2.96 billion in the quarter. Core operating margins grew 10 bps as organic revenues growth and productivity gains offset headwinds from higher operating costs.
2014 Outlook Increased
Management increased its previously provided earnings outlook for 2014 while maintaining expectations of sales growth.
In 2014, Pepsi expects core constant currency earnings per share to be approximately $4.72, representing an increase of 8% from $4.37 reported in 2013. Previously, the company was expecting an earnings growth of 7%. The target is in line with management’s long-term goal of high single-digit core constant currency earnings growth.
Excluding headwinds from currency and structural changes, organic revenues are expected to grow in the mid single-digit range, also in line with the long-term targets.
Currency is expected to hurt 2014 earnings per share and revenues by 4% and 3%, respectively.
The rate of commodity inflation is expected to be higher in 2014 than in 2013. Commodity inflation is expected in the low single-digit range in 2014. Productivity savings are expected to amount to $1 billion in 2014, which will be used to offset headwinds from cost inflation and thereafter, reinvest in the business. The core tax rate is expected to be approximately 25% for 2014, slightly lower than the 2013 level. Moreover, interest expenses are expected to be higher than 2013 due to increased debt balances.
Also, management maintained its plan to increase cash returns to shareholders in 2014 by 35% to $8.7 billion through significant hikes in dividends and share repurchases.
Another beverage maker, The WhiteWave Foods Company (WWAV) also has the same Zacks Rank as Pepsi.
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