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PepsiCo’s (PEP) Cost-Cut Efforts to Impress Amid Macro Woes

Zacks

On May 19, we issued an updated research report on PepsiCo Inc. PEP, one of the leading global food and beverage companies.

PepsiCo’s shares gained around 13.9% in the last one year, outperforming the 6.7% growth of the Zacks Consumer Staples sector. However, the company’s shares have performed almost in line with the Zacks categorized Beverages-Soft Drinks industry’s gain of 8.8% year to date.

Shifting consumer preference toward healthier food categories, rising volatility in global markets and increasing currency headwinds may dampen growth. That said, PepsiCo stepped up cost-saving initiatives along with increased marketing investments and package and product innovations are expected to boost its profitability.



First-Quarter 2017 Highlights

PepsiCo reported better-than-expected results in first-quarter 2017, with both earnings and revenues beating the Zacks Consensus Estimate. The company’s top line increased 1.6%, while the bottom line grew 5.6% on lower tax rate and higher interest income.

Due to challenging food and beverage industry trading conditions in North America and continued volatility in a number of developing and emerging markets, PepsiCo’s organic revenue grew by a modest 2.1%, mainly driven by higher pricing. However, organic sales growth was lower than the 3.7% rise recorded in the previous quarter.

In the developing and emerging markets, despite volatility, the company witnessed mid-single-digit organic revenue gains in the quarter. The company’s two largest developing and emerging markets, Mexico and Russia, saw growth across snacks, beverages and dairy. This led to high single-digit organic revenue growth in each of these important markets.

However, the company’s total operating performance seems to be lackluster. Core gross margins contracted 45 basis points (bps) year over year. Core operating margin contracted 28 bps on lower gross margin gains. Again, core constant currency operating profit increased only 1%.

Currency headwinds and persistent sluggish carbonated soft drinks (CSD) volumes are pressing concerns for this beverage giant as well as for other nonalcoholic beverage companies such as The Coca-Cola Company KO and Dr Pepper Snapple Group, Inc. DPS. Health-conscious consumers are shifting from soda beverages to still or noncarbonated beverages.

Foreign exchange (Fx) is a major headwind for PepsiCo with around 34% of its revenues coming from outside the U.S. Though the dollar has weakened only slightly in 2016, the negative currency impact is quite significant. Currency headwinds are expected to hurt 2017 revenues by 2% and 3% on EPS.

Innovations, Productivity Improvements and Cost-Saving Efforts Bode Well

Despite global macro challenges, Pepsi has been doing well since 2014 on the back of significant innovation, ongoing revenue management strategies, improved productivity and better market execution.

To counter the slowing CSD trend, PepsiCo is banking on innovations focusing on healthier snack food options and seeking growth in the still or noncarbonated beverages category. Currently, 45% of PepsiCo’s total net revenue comes from “Guilt-Free” products, more than half of which comes from the “Everyday Nutrition” category. This percentage is likely to increase given the company’s stepped up innovation and focus on adapting to changing consumer preferences.

Again, the company’s focus on driving both efficiency and effectiveness, has resulted in annual savings of approximately $1 billion since 2012 and is expected to generate approximately $1 billion in 2017.

In Feb 2014, the company announced a new five-year restructuring plan to generate annual productivity savings of $1 billion from 2015 to 2019 per year through next-generation productivity initiatives. The savings are coming from improved efficiency through increased manufacturing automation, optimization of global manufacturing including the closure of certain manufacturing facilities and increasing capacity utilization, re-structuring go-to-market systems in developed markets, expanding shared services and simplifying organization structures.

Savings from these investments and technology and operational changes are being re-invested in the business to drive top-line growth.

Zacks Rank & Key Pick

PepsiCo currently holds a Zacks Rank #3 (Hold).

A better-ranked stock in this industry is Embotelladora Andina S.A. AKO.B, carrying a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

For full-year 2017, Embotelladora Andina’s EPS is expected to grow 36.5%.

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