Pepsi delivered EPS in Q3 above consensus estimates, beating the street by $.06. This was due in part to cost cutting programs and favorable tax treatment. Management increased its EPS growth guidance as it reduced its outlook for forex headwinds. PEP fell short on organic sales growth. This was due to negative effects of cooler summer weather and the recent hurricanes on its North American Beverages unit. Management is confident these are temporary issues.
Current Price: $109 Price Target: $117
Position Size: 2.35% TTM Performance: +4.7%
Thesis Intact:
1. Key takeaways from the quarter:
a. 1Q17 organic revenue growth of +1.7% (consensus +2.7%).
o Frito-Lay North America +3% vs consensus +4.2%
o Quaker Foods North America +1.0% vs consensus +1.0%
o North America Beverages -5.0% vs consensus -1.0%
o Latin America +6.1% vs consensus +6.0%
o ESSA +6.0% vs consensus +4.0%
o AMENA +2% vs consensus +6.5%
b. The miss on organic revenue growth was driven mainly by underperformance in the North American beverages segment. Weather was competitively negative, both temperature and precipitation following record hot summers in 2015 and 2016. This hurt sales of Gatorade, which generally accounts for a fifth of sales volume in the segment. They lagged the industry in carbonated beverages as they have dedicated more spending and shelf space to more nutritious low calorie brands.
2. PEP increased EPS growth estimate to +9% and FY 2017 EPS to $5.23. However, PEP decreased its 2017 guidance of organic top line growth from at least 3.0% to 2.3%. From the call, growth outlook is generally positive across the globe:
a. In the US, YTD PEP has generated more retail food and beverage revenue growth than all other 5 billion plus manufacturers combined
b. Latam posted strong organic revenue growth despite challenging macroeconomic conditions
c. China, Pakistan, Philippines, and Egypt recorded double digit organic revenue growth
d. In Europe and sub-Sahara Africa, saw organic growth in 10 of 11 key markets, translating to margin expansion and 12% core constant currency operating profit growth
e. Middle East: the region is still hurt by the oil crisis
3. Valuation:
a. 5% real cash yield (3% dividend yield and 2% buyback yield). Pepsi is returning 100% of free cash to shareholders
Thesis on Pepsi:
• Global growth opportunity with about 40% of profits coming from outside the US. CSD is only 25% of sales (and Pepsi brand only 12%)
• Strong market share in high growth emerging markets where there is low penetration and rising per capita consumption
• Resilient snack business provides pricing power and visibility to future cash flows (more than half of sales are from snacks not beverages). CSD is only 25% of sales (and Pepsi brand only 12%)
• Several Great brands driving global growth: Frito Lay, Quaker, Gatorade
• Strong balance sheet and cash flows support a solid dividend yield and share buyback program