05 April 2008

PEP: Look Ahead to 2008 First Quarter Results

In our financial analysis of PepsiCo's (PEP) fourth quarter of 2007, we noted that Revenue was an impressive 16.8 percent greater than in the December 2006 quarter. Revenue growth in international operations was especially strong, up 26 percent. The weak dollar accentuated the sales surge, but PepsiCo also reported gains in both volume and pricing. On the other hand, the dollar's drop has also contributed to rising prices for agricultural commodities, which increase PepsiCo's costs and squeeze profits.

Slowing income growth, coupled with a stock price that soared 21 percent in 2007, knocked down PepsiCo's Overall Gauge score by almost half to 23 out of 100 possible points. As can be seen in the chart, we have reason to worry about future stock price performance when the Overall score falls in the 20's.

While PepsiCo shares slipped a few dollars in the first quarter of 2008, we're not sure that will be enough to bump up the Value gauge and, thus, the Overall score when the first quarter operating results are released later this month.

In the earnings announcement for 2007's fourth quarter, PepsiCo provided guidance for 2008. Among other things, they stated:
For 2008, the Company expects 3% to 5% volume growth, mid-to-high single digit net revenue growth and EPS of at least $3.72. The Company expects total worldwide input cost inflation to be in the mid-single-digit range. The tax rate is expected to be about 27.5%.

Given that PepsiCo has, of late, been surpassing its guidance, we believe $8.0 billion is a reasonable estimate for first-quarter 2008 Revenue. This figure would equate to 12 percent year-over-year revenue growth and a 9 percent increase over the December 2006 quarter.

The Gross Margin for PepsiCo has long been about 55 percent of Revenue, but we will be surprised if they do better than 54 percent in the first quarter because of rising prices. Therefore, we're estimating the Cost of Goods Sold at (1 - 0.54) * $8.0 billion = $3.7 billion.

SG&A expenses are normally near 35 to 36 percent of Revenue (except in the fourth quarter, when they increase by several percentage points). Our assumption for these costs in the first quarter is 0.355 * $8.0 billion = $2.8 billion. We'll also assume a $15 million charge for amortization of intangible assets.

Bottler equity income is both significant and erratic, but it tends to be relatively weak in the first quarter. We will, somewhat arbitrarily, assume it will be $100 million in the March 2008 quarter.

A $25 million charge for Net Interest Expense seems reasonable given recent history.

For the first quarter income tax rate, we're using the company's full-year guidance of 27.5 percent. The rate has been surprisingly volatile from quarter to quarter, which can throw earnings estimates out of whack.

Rolling up these estimates, we're looking for Net Income of $1.1 billion ($0.68/share) for the quarter. The comparison with the year-earlier is not as favorable as one might expect because the tax rate in the year-earlier period was almost 2 percent below the current estimate.

Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.


March 2008
March 2007
Op expenses

CGS (3680)

SG&A (2840) (2635)

Operating Income
Other income

Equity income

Interest, etc.
Pretax income

Income tax

Net Income


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