02 June 2008

PEP: Look Ahead to June 2008 Results

In our financial analysis of PepsiCo's 12-week quarter that ended 22 March 2008, we noted that the three business units that operate outside North America registered an average sales gain of 30 percent. Strong international performance, aided by the weak dollar, enabled PepsiCo as a whole to achieve better-than-expected Revenue growth.

However, currency changes are something of a double-edged sword, as it increases PepsiCo's raw material (i.e., agricultural commodities) costs. The resulting curb on Net Income and Cash Flow growth led to the second consecutive quarter with an Overall Gauge score of 23, out of 100 possible, points.

As can be seen in the chart, 23 points is near the low end of the range for PepsiCo, and share price declines are more likely to occur when the score is weak.

While PepsiCo's share price has given up some of its earlier gains, only time will tell whether the fall will be enough to bump up the Value gauge and, thus, the Overall score.

PepsiCo, Inc. (PEP) is a leading global purveyor of beverages and snacks. The company is known for good management, steady growth, significant international exposure, and the defensive characteristics of the food and beverage industries. While famously locked in a battle with Coca-Cola (KO) for the soft-drink market, PepsiCo's snack food business diversifies the company. The Frito-Lay North America division takes in more Revenue, and it contributes more to Operating Profit, than the PepsiCo Americas Beverages unit.

On 17 July 2008, PepsiCo will report its results for the 12 weeks ending 14 June. In anticipation of this report, we've modeled PepsiCo's Income Statement for the quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data. GCFR estimates are derived from trends in the company's historical financial results and guidance provided by company management.

When announcing its first quarter results, the company reiterated its full-year outlook as follows:

Company expects 2008 performance to be consistent with long-term targets.

For 2008, the Company expects 3% to 5% volume growth, high-single-digit net revenue growth and EPS of at least $3.72. The Company expects 9% to 10% total worldwide commodity cost inflation. The tax rate is expected to be about 27.5%.

Cash provided by operating activities is expected to be approximately $7.6 billion and capital spending about $2.7 billion. The Company intends to spend $4.3 billion in share repurchases.

To establish a Revenue target for the quarter, we start with the company's guidance for the year of "high-single-digit" growth. We assume this means somewhere between 7 and 9 percent, but for convenience we'll use 8 percent. Revenue in the full year of 2007 was $39.5 billion, so management's expectation for 2008 is probably near $42.7 billion. In the last five years, the June quarter has contributed an average of 24.2 percent of the year's Revenue. Therefore, our Revenue target for the June 2008 quarter is 0.242 * $42.7 billion = $10.3 billion.

With commodity prices on the rise, we expect to see continued pressure on PepsiCo's Gross Margin. The margin in the June 2007 quarter was 54.8 percent, and we'll guess it will come down to 54.0 percent. In other words, we're estimating the Cost of Goods Sold at (1 - 0.54) * $10.3 billion = $4.75 billion.

SG&A expenses are typically between 34 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 0.35 * $10.3 billion = $3.6 billion. We'll also assume a $15 million charge for amortization of intangible assets, which has been the average charge in the last four quarters.

These assumptions would lead to Operating Income, as we define it, of $1.95 billion. This would be about the same as the year-earlier quarter.

Bottler equity income is both significant and erratic. In the last four quarters, equity income was about the same as in the previous four quarters. Therefore, we will assume equity income in the June 2008 quarter equal to the $173 million of June 2007 quarter.

A $25 million charge for net Interest Expenses seems reasonable given recent history.

For the second 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 figures, we're looking for Net Income of $1.52 billion ($0.94/share) for the quarter. This is considerably below the consensus analyst 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.


June 2008
June 2007
Op expenses

CGS (4753)

SG&A (3616) (3295)

Operating Income
Other income

Equity income

Interest, etc.
Pretax income

Income tax

Net Income

Shares outstanding


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