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PepsiCo - strong results, but guidance weak

Sophie Lund-Yates, Equity Analyst | 13 February 2020 | A A A
PepsiCo - strong results, but guidance weak

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PepsiCo Inc. Comm Stk US$ 0.0166

Sell: 131.50 | Buy: 131.55 | Change -0.74 (-0.56%)
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Pepsi reported fourth quarter organic revenue growth of 4.3% to $20.6bn. Operating profit fell 3% to $2.7bn excluding the impact of exchange rates, reflecting increased costs and marketing spend.

The group announced its 48th consecutive annual dividend increase: a 7% rise to $4.09 per share.

The shares were unmoved in pre-market trading.

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Our view

As the owner of the world's second largest cola brand, at first glance Pepsi looks like Coca-Cola writ small. But Pepsi's annual sales are actually almost twice that of its more famous rival.

Like Coca-Cola, Pepsi has a diverse mix of top quality brands - 22 of which generate $1bn or more of sales a year. But unlike Coca-Cola, it doesn't limit itself to soft drinks. PepsiCo's products include snack brands such as Walkers crisps and Doritos, and some more unexpected names - Quaker Oats with your fizzy drink?

Recent years have seen a concerted effort to focus on Pepsi's healthy credentials. That might seem a bit odd for a company whose main business is crisps and soft drinks. But consider for a moment that Pepsi MAX has been the focus of all Pepsi advertising in the UK since 2005, and perhaps it's not so surprising.

A laser-like focus on brand quality and margins, have kept profits slowly moving forwards and management reckons there's more in the tank. Pepsi's looking to deliver 4-6% annual revenue growth and a 0.2-0.3 percentage point improvement in margins over the long term. All being well, the combination of revenue and margin growth should be very good news for profits.

Hopefully that will see Pepsi build on 48 consecutive years of dividend growth - a formidable record even if it isn't repeated in the decades ahead. PepsiCo currently offers a prospective yield of 2.8%, not an indicator of future returns.

It's worth keeping half an eye on Pepsi's business model though, which varies considerably by region. It'll manufacture products in some markets, while in others it hands over almost complete control to a licencing partner - such as Britvic in the UK. On the one hand that makes Pepsi more capital intensive thanks to investments in factories and production equipment, increasing risk. But it's also allowed manufacturing processes to benefit from scale, with $1bn in cost savings planned for every year out to 2023.

We consider Pepsi's variety of brands and focus on healthier options clear attractions. However with the stock on a PE ratio well above its long run average, only time will tell if the less focussed, but perhaps more forward thinking business model can deliver the necessary results in the years ahead.

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Fourth Quarter Results (all profits are core, growth is organic and at constant currency)

The Frito-Lay North America (25% of revenue) division grew sales 3% to $5.1bn, reflecting a 2% rise in volumes. Operating profit rose 1% to $1.6bn, as cost savings offset higher costs and marketing spending. The division remains the largest contributor to group profit.

Pepsi Beverages North America (30.3% of revenue) saw flat volumes and a 3% increase in revenue to $6.3bn. However, operating profit fell 7% to $469m, driven by higher costs, commodity prices and marketing spending.

Quaker Foods North America saw volumes grow 1% and sales remain flat at $772m, but operating profit fell 24% to $153m for the same reasons as Pepsi Beverages.

Europe delivered 6% revenue to $3.9bn and operating profit rose 7% to $446m. At the headline level, the recent acquisition of SodaStream offset the divestment of some operations in Central Europe.

Latin America saw a strong volume performance in beverages more than offset weaker snack sales, with overall revenues up 6% to $2.5bn. Productivity savings drove operating profit up 14% to $375m.

Net debt at the end of the quarter stood at $26.6bn, up from $23.6bn at the end of the last financial year. That reflects the acquisition of Soda-Stream earlier in the year as well as increased investment. The group generated $5.6bn of free cash flow during 2019.

Management expects revenue growth of 4%, earnings per share growth of 7%, and to generate around $6bn of free cash in 2020.

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