Pepsi reported 4Q17 earnings in line with estimates of organic sales +2.3% and EPS growth of +8%. Management provided its initial 2018 guidance which is a bit light vs. expectations, but certainly achievable for Pepsi. We will look for a positive margin progression in the coming quarters as new products come to the market. Currently the stock is supported by an increased dividend and new repurchase program. Price target unchanged at this time.
Current Price: $111.8 Price Target: $117
Position Size: 2.3% TTM Performance: +4.3%
Thesis Intact:
1. Key takeaways from the quarter:
a. 4Q17 organic revenue growth of +2.3% (consensus +2.3%).
o Frito-Lay North America +5% (+3% volume & +2% price is very good)
o Quaker Foods North America flat y/y
o North America Beverages -3% weak (volume -2%)
o Latin America +3%
o ESSA +6%
o AMENA +6%
b. Operating margins of 14.3% increased by 70bps y/y, but this was driven mostly from a bottler refranchising gain in Jordan, as gross margins decreased by 50bps
2. PEP provided its initial 2018 guidance:
a. Organic sales growth at least in line with 2017 is a bit disappointing. New product innovation in 2018 should help sluggish beverage sales.
b. FX impact neutral based on current rates
c. Tax rate in the low 20%
d. EPS of $5.70 (+9%)
e. Dividend per share increase of 15%
f. Total cash returned to shareholder expected to be $7B ($2B in buybacks) in 2018.
g. New $15B repurchase program from mid-2018 to 2021 is a positive
h. Guidance includes reinvestment from the tax reform benefits into US front-line workforce and capabilities in the US
i. Some of the reinvestments have to be made even though they will not drive an increase in top line, as the cost of doing business has gone up:
a. Cyber security investments
b. Food safety
3. Valuation unchanged at this time:
a. ~5% real cash yield (2.9% 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
$PEP.US