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PepsiCo - bubbling back

Emilie Stevens, Equity Analyst | 1 October 2020 | A A A
PepsiCo - bubbling back

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

PepsiCo Inc. Comm Stk US$ 0.0166

Sell: 143.66 | Buy: 143.68 | Change 1.34 (0.94%)
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Pepsi's underlying third quarter revenue rose 4.2% to $18.1bn. Core earnings per share rose 9% to $1.66.

Management expects full year revenue to increase 4% and core earnings per share to fall from $5.53 to $5.50. The group also expects to generate $6bn in free cash and return $7.5bn to shareholders through share buybacks and dividends.

The shares rose 1.4% 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 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 health 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 had been looking to deliver 4-6% annual revenue growth and a 0.2-0.3 percentage point improvement in margins over the long term. We thought COVID-19 would knock these targets back a bit, but management is still expecting 4% revenue growth this year. 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.

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.

Debt has crept up though, and as it stands net debt is 2.7 times last year's cash profits. Pepsi is strong company and can generate a lot of cash, but as debt grows management's room for manoeuvre could get constrained. We're not worried, but we're keeping an eye on it.

Overall 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.

Pepsi key facts

  • Current 12m forward P/E ratio: 23.9
  • 10 year average 12m forward P/E ratio: 19.0
  • Prospective yield: 3.1%

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Second Quarter Results

Frito-Lay North America grew underlying sales 6% to $4.4bn, reflecting both higher volumes and higher prices. Core operating profit rose 4% to $1.4bn, primarily reflecting revenue growth, partially offset by a 3 percentage point impact from COVID-19 related costs and higher operating costs and marketing spend.

Quaker Foods North America grew revenue by 6% to $608m. The pandemic drove higher demand from customers, with pasta, light snacks and oatmeal performing well. Core operating profit rose 14% to $145m as revenue growth and productivity savings were partially offset by higher costs, including a 2.5 percentage point reduction from COVID-19.

Pepsi Beverages North America saw revenue grow 3% to $6.0bn, despite a 1.5% fall in volume. Core operating profit rose 12% to $743m, which management attributed to lower costs despite an 8 percentage point impact from COVID-19. Impairment charges to a coconut water brand and a prior year insurance recovery also reduced operating profit growth.

Revenue in Latin America rose 1% to $1.7bn, reflecting growth in snacks and a decline in beverages. Core operating profit rose 0.5% to $255m, although headline operating profit fell 10% reflecting adverse foreign exchange movements and the impact of COVID-19.

In Europe revenue rose 7% to $3.3bn as both snacks and beverages sales increased. Core operating profit rose 8% to $493m despite COVID-19 causing a 3.5 percentage point reduction.

Asia Pacific, Australia and New Zealand and China Region (APAC) revenue rose 15% to $897m and core operating profit fell 1% to $169m. Africa, Middle East and South Asia (AMESA) revenue fell 2% to $1.3bn and core operating profit fell 5% to $205m.

Net debt at the end of the quarter rose to $35.5bn, up from $26.6bn at the end of 2019. Over the nine month period Pepsi generated $4.1bn in free cash.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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