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PepsiCo - earnings up, guidance withdrawn

Nicholas Hyett, Equity Analyst | 28 April 2020 | A A A
PepsiCo - earnings up, guidance withdrawn

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PepsiCo Inc. Comm Stk US$ 0.0166

Sell: 129.75 | Buy: 129.81 | Change -0.73 (-0.56%)
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Pepsi's first quarter revenue increased 7.9% to $13.9bn, while operating profit grew 6% to $2.1bn. Core earnings per share grew 10% at constant currency to $1.07.

Given ongoing uncertainty related to COVID-19, Pepsi is withdrawing previous guidance. However the group still expects to return around $7.5bn to shareholders this year, of which $5.5bn will be dividends and $2bn share buybacks.

The shares were up 1.5% 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?

This diversity has helped Pepsi weather the coronavirus outbreak reasonably well. Pure-play drinks makers, like rival Coca-Cola, have suffered as the sales usually made through pubs and restaurants have been hit hard by lockdowns. Pepsi's food products have done well here, although the outlook is uncertain enough for the group to withdraw its previous guidance.

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 3.1%, 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, although coronavirus may put these plans on hold.

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

The Frito-Lay North America division grew sales 7% to $4.1bn, reflecting a 5% rise in volumes. Operating profit rose 6% to $1.2bn, as the COVID-19 pandemic increased demand for products like Cheetos and Tostitos.

Pepsi Beverages North America saw volumes increase 6% revenue increase by the same amount to $4.8bn. However, operating profit fell 24% to $300m, mainly due to charges taken as a result of the coronavirus pandemic.

Quaker Foods North America saw volumes grow 8% and sales 6% to $634m. Operating profit grew 9% to $151m, mainly reflecting higher volume growth and productivity savings, offset by unfavourable net pricing and higher marketing costs.

Europe delivered 14% revenue growth to $1.8bn and operating profit rose 13% to $154m. Operating profit growth was impacted by an insurance settlement recovery in Russia, charges and fair value adjustments associated with the SodaStream acquisition and lower commodity costs.

The Latin America division grew revenue 8% to $1.3bn, while operating profit rose 3% to $236m. This reflects cost increases, higher marketing spending and higher commodity prices.

Net debt at the end of the quarter rose to $30bn, up from $26.3bn on 28 December 2019. The group reported negative free cash flow during the quarter of $1.2bn, primarily reflecting cyclical changes in working capital.

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