Earnings Preview: PepsiCo (PEP)

Pepsico Inc. (PEP) is scheduled to release its second-quarter 2010 results on Tuesday, July 20. The Zacks Consensus Estimate for the company is $1.09 a share.

First Quarter Performance

Pepsico Inc. reported strong first quarter results with earnings of 89 cents per share. This was well above the Zacks Consensus Estimate of 75 cents and up 23% year over year. Profits were driven by the acquisition of its two anchor bottlers, volume gains in its worldwide snacks and international beverage businesses, balanced investments and lower costs across its operations.

Net sales for the quarter increased by 13.4% year over year to $9.4 billion. Gross margins for the quarter contracted 233 basis points (bps) to 52.4% versus 54.7% in the comparable prior-year quarter. The operating profit for the quarter also reduced to $840 million compared with $1.6 billion in the prior-year quarter.

Cash and cash equivalents for the year were $3.9 billion. The company has a debt-to-capitalization ratio of 47.6%.

Concurrent with the earnings release, management provided guidance for fiscal 2010. The company is targeting a 11% to 13% growth rate for constant currency EPS.

Agreement of Analysts

Just two analysts moved their estimates in the downward direction over the last 30 days, with no upward movement by any analyst for either the second quarter or fiscal 2010. This implies that most of the analysts are neutral on the outlook and do not foresee any upward catalyst or downward pressure on the shares. A similar trend has been noticed for both the third quarter of fiscal 2010 and the full fiscal 2011.

Magnitude of Estimate Revisions

There has been no movement in estimates by analysts for next two quarters or fiscal 2010. However, fiscal 2011 portrays the negative sentiment of analysts with a downward revision of 1 cent in estimate.

Earnings Surprise

Considering earnings surprise, the stock has been almost steady over the last four quarters, with positive surprises in the three quarters and a negative surprise in one quarter, ranging between a low of negative 1.10% and a high of 4.85%. The average remained positive at 1.77%. This implies that Pepsico has surpassed the Zacks Consensus Estimate by 1.77% over the said period.

The upside potential for the estimate in the second quarter, essentially a proxy for future earnings surprises, currently stands at 0.00%.

Our Recommendation

Pepsico should witness an increase in volume trends in the second quarter of fiscal 2010, attributable to pricing promotion and favorable weather conditions. The company has the ability to post a strong growth in earnings attributable to moderating input cost inflation, various initiatives to boost productivity and share repurchase activity.

Pepsico has begun to step-up investments in targeted areas that will support improved growth and profitability in 2010 and beyond. The company is making infrastructure investments in developing markets such as China to drive increased penetration and distribution of both carbonated and non-carbonated beverages. It has also increased investments in research and development.

Pepsico has significant long-term growth opportunities from the integration of its bottlers, international expansion, and strong snack and beverage brands. However, these factors are expected to have a limited impact on margins and earnings in the near term.

Challenges for Pepsi persist throughout the remainder of 2010 amid a high unemployment rate and rising costs. However, the move to consolidate its bottlers will provide a catalyst for higher volume.

Pepsico’s shares maintain a Zacks #4 Rank, which translates into a short-term Sell recommendation. Our long-term recommendation for the stock remains Neutral.

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