PepsiCo Inc (PEP) Comm Stk USD0.0166 (Crest Depository Interest)

Pepsi’s revenue grew by 2.7% on an organic basis, reaching $18.3bn in the first quarter. This was driven entirely by higher prices as volumes declined by around 2.0%.

Underlying operating profit rose by 5.0% to $2.9bn, ignoring the impact of exchange rates. This was helped by price hikes and cost-saving measures.

Free cash outflows worsened from $1.0bn to $1.6bn. Net debt rose by $3.4bn to $37.5bn since the start of the year.

Full-year guidance has been reiterated, with revenue expected to grow by 4% on an organic basis. The group expects to return around $8.2bn of cash to shareholders this year, through a combination of dividends and share buybacks.

The shares were broadly flat in pre-market trading.

Our view

First-quarter results highlighted that continued price hikes are becoming increasingly difficult for consumers to stomach, pushing volumes in the wrong direction. This issue hasn’t been helped by recalls of some Quaker Oats products after concerns that they could be contaminated with salmonella bacteria.

Cost-cutting initiatives have continued at pace though, helping to offset some of the impacts of lower volumes and keeping profits moving higher. That's impressive but remember, cost cuts are more like a plaster than a longer-term treatment.

Looking ahead, we anticipate easing cost inflation, which should slow the rate of price hikes and revive some demand for Pepsi's products. Growth from a more sustainable mix of price and volume would be welcome.

Longer term, we're not too worried. Pepsi boasts a wide range of top-quality brands. And unlike rival Coca-Cola, it doesn't limit itself to soft drinks. Pepsi's products include snack brands such as Walkers crisps and Doritos.

Pepsi's business model varies considerably by region. It'll manufacture products in some markets, and in others, it hands over almost complete control to a licensing 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.

At $37.5bn, or just over two times expected cash profits (EBITDA), net debt is higher than we’d like. It’s not cause for concern at the moment, but we’d hope to see this start to come down again, especially as interest rates now look set to remain higher for longer, which increases the cost of rolling this debt over.

Overall, we consider Pepsi's variety of brands and history of strong execution a real bonus. But with volumes moving in the wrong direction, we're likely to see the rate of price hikes slow this year, and revenue and profit growth along with it.

Pepsi's valuation sits slightly below its long-term average. But trading at 21.1 times forward earnings puts heavy expectations on its shoulders - meaning the shares could still be sensitive to stock market fluctuations or earnings disappointments. Right now, there are other names in the sector that look more attractive to us.

Environmental, social and governance (ESG) risk

The food and beverage industry tends to be medium-risk in terms of ESG though some segments like agriculture, tobacco and spirits fall into the high-risk category. Product governance is a key risk industry-wide, especially in areas with strict quality and safety requirements. Labour relations and supply chain management are also industry-wide risks, with other issues varying by sub-sector.

According to Sustainalytics, Pepsi’s management of ESG risk is strong. The group has strong anti-bribery and adequate human rights policies in place. Despite this, Pepsi is involved in significant human rights issues within its supply chains. Pepsi is also exposed to food safety issues that could result in customer health impacts and associated lawsuits which could potentially damage the brand and lead to financial repercussions.

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