Key Takeaways:
Pepsi released Q2 earnings that were better than expected (granted on recently lowered sell-side expectations). Organic growth was +2.6% (consensus +2.2%). North America beverages remains soft, but saw sequential improvements following additional advertising efforts + new products (Bubly and Gatorade Zero), and should see continued positive momentum in 2H18. Frito Lay’s good performance in price and volume helped lift the overall company’s gross margin (positive mix impact). The emerging markets had strong growth +6% even with the Brazil truck driver strike limiting distribution of goods. As I had mentioned leading up to this earnings season, the company (as well as other consumer staples) is experiencing higher commodity and freight costs. Since a good portion of this quarter’s growth came from one-time items (Thailand beverage refranchising for example), the quality of growth going forward needs to be monitored. The company reiterated its FY18:
ü organic revenue growth of at least +2.3%
ü EPS +9% y/y.
Some sell-side analysts are pushing for a US refranchising of the bottlers (like KO did in the past years, lifting ROIC and shifting some commodity costs risks to the bottlers). This is not without risks of execution/disruption but should be viewed positively by investors. In the past PEP was a big believer in keeping the bottling business within the company.
Comments on their ESG initiatives: PEP started its “Performance with Purpose” 12 years ago. Since then PEP has:
Providing “better for you” alternatives in snacking and beverages
Responsible corporate water steward: invested more than $40M to provide safe water access around the world
Delivery fleet more energy efficient since using electric vehicle starting in 2010
Making beverage coolers and vending machines 60% more energy efficient
World’s largest purchaser of recycled PET
Launched the 1st 100% compostable chip bag in test markets
Offering on-site childcare
Valuation:
- ~5% real cash yield (~3% dividend yield and 2% buyback yield). Pepsi is returning 100% of free cash to shareholders. We are maintaining our price target.
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
[tag PEP]
Julie S. Praline
Director, Equity Analyst
Direct: 617.226.0025
Fax: 617.523.8118
Crestwood Advisors
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Boston, MA 02109
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