22 April 2009

PEP: Financial Analysis through March 2009

PepsiCo, Inc., (NYSE: PEP) earned $0.72 per share during the 12 weeks that ended on 21 March 2009.  This post provides the GCFR analysis of this period, which was the first quarter of fiscal 2009.

We will adjust the results, as necessary, after PepsiCo files a 10-Q report with the SEC.

First, we present some background information.

PepsiCo, Inc., is a leading global purveyor of beverages and snacks.  The company is well regarded for good management, steady growth, significant international exposure, and the defensive characteristics of the food industry.  While famously locked in a battle with Coca-Cola (NYSE: 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.

The company is reducing its workforce and number of plants.  This plan, under the banner "Productivity for Growth," led to pretax charges in the fourth quarter of 2008 totaling $543 million.  Additional related charges of $32 to $57 million are expected in fiscal 2009.

In conjunction with the release of first-quarter earnings, PepsiCo also announced it would offer to buy the shares it does not already own in Pepsi Bottling Group, Inc. (NYSE: PBG) and PepsiAmericas, Inc., (NYSE: PAS), which are its two largest bottlers.

For 2009, PepsiCo shuffled some international businesses from one reporting segment to another.  The fourth quarter of 2008 was the first to include financial results for the recently acquired potato-chip maker Marbo in Serbia and the juice-maker Lebedyansky in Russia.  The latter was a joint acquisition with PBG.

The company also changed how it reports "bottler case sale" volume in North America.  This change does not affect GCFR analyses.

In the fourth quarter of 2008, PepsiCo earned 43 percent less than in the year-earlier period.  The results were adversely affected by the implementation of cost-cutting initiatives and by the stronger U.S. dollar.  Revenue in the December 2008 quarter was up only 3.1 percent.  Differences in currency exchange rates had a significant negative effect on Revenue figures expressed in Dollars.   We were more concerned by the flat performance of PepsiCo's Food and (especially) Beverage operations in the Americas because we thought these businesses would be more immune than most to economic swings.

Nevertheless, despite some concerns, the GCFR Overall Gauge of PepsiCo rose from 32 to 52 during the fourth quarter.  The increase was due to upward moves by the Profitability and Value gauges, which overcame big fall in the Growth gauge.  The contrarian Value gauge jumped in response to PepsiCo's share price falling from $71.27 to $54.77 during the last three months of 2008 (the price fell a little further during the first quarter of 2009).  The Profitability gauge also had a positive reaction to change in metrics such as ROICFree Cash Flow to Invested Capital, and the Accrual Ratio

Now, with the newly reported first-quarter data, our gauges display the following scores:

  • Overall: 49 of 100 (down from 52)

Before examining each gauge, we will compare the latest results to our previously posted Income Statement model for PepsiCo.

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.


Revenue in the first quarter was 0.8 percent less than in the year-earlier quarter, just slightly better than the 1.0 percent decline we had expected.  It's surprising we were so close because we had to consider PepsiCo's performance and changes in foreign exchange rates.  (The effect of currency changes on Revenue is a major concern because PepsiCo's operations outside of the U.S. generated 48 percent of Revenue in 2008.)

The Cost of Goods Sold in the quarter equaled 45.3 percent of Revenue, which translates into a Gross Margin of 54.7.  Our estimate for the Gross Margin was a much weaker 52.5 percent.  The actual Gross Margin had not been this high since June 2007, and we certainly didn't expect it.

Sales, General, and Administrative (SG&A) expenses were 35.4 percent of Revenue, a notch below our estimate of 36.4 percent.  This is another example of good cost control exhibited during the first quarter.

The charge for Amortization of Intangible Assets was $5 million less than expected.

The much better-than-expected Gross Margin resulted in Operating Income, as we define it, beating the value we forecast by an impressive 21 percent.  Operating Income was 2.0 percent above that in last year's first quarter. 

We rarely do well at predicting the erratic "Bottling equity income," and this quarter was no exception.  Our target was income of $50 million, and the actual figure was $25 million. 

The Net Interest Expense was $23 million more than we expected, reflecting higher debt levels (see below).

The Income Tax Rate was 24.7 percent, down from 26.7 percent in the year-earlier quarter.  The rate was well below our 27 percent expectation.  

Net Income in the quarter was 1.1 percent below that in the year-earlier period, but it was 21 percent above our prediction.  Earnings per share were up 2.8 percent because fewer shares were outstanding.

Cash ManagementMarch 2009
3 months prior
12 months prior
Current Ratio1.4
1.5 yrs
1.2 yrs
0.9 yrs
42.6 days
43.2 days44.8 days
Finished Goods/Inventory
Days of Sales Outstanding (DSO)39.8 days
38.3 days
40.3 days
Working Capital/Invested Capital 14.9%
Cash Conversion Cycle Time-49 days
-59 days
-45 days
Gauge Score (0 to 25)

The dramatic increasing of long-term debt continued into the first quarter.  Debt rose from $4.2 billion to $7.9 billion during 2008, and the amount is now $9.2 billion.  In 2008, PepsiCo spent $4.7 billion in cash to repurchase its common shares.  We would prefer that debt, if necessary, be used for capital investments that will spur growth and profitability.

Inventory, something we watch very closely, is down 2 days from March 2008.  The lower proportion of finished goods in the Inventory is a plus.

GrowthMarch 20093 months prior
12 months prior
Revenue growth6.7%
Revenue/Assets 122%
CFO growth
Net Income growth -10.1%
Gauge Score (0 to 25)0
Growth rates are trailing four quarters compared to four previous quarters.

The Revenue growth rate weakened as the recession took hold and as the dollar strengthened against other currencies.  In addition, restructuring expenses added to the fall in Cash Flow and Net Income.  We're pleased, however, that Revenue remained steady in relation to Assets.

ProfitabilityMarch 20093 months prior
12 months prior
Operating Expenses/Revenue 83.7%
ROIC 27.0%
Free Cash Flow to Invested Capital19.7%
Accrual Ratio
Gauge Score (0 to 25)11

Operating Expenses, which had been increasing, improved slightly.   Nevertheless, some deterioration is seen in PepsiCo's Returns on Invested Capital.  The recent increase in the Accrual Ratio, which suggests weakening earnings quality, indicates that less the company's Net Income is due to Cash Flow from Operations (CFO).

ValueMarch 20093 months prior
12 months prior
P/E 15.8
P/E to S&P 500 average P/E 89%
Price/Revenue 1.9
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)16

The value metrics became more appealing as PepsiCo's stock price dropped from $54.77 to $51.48 from the end of December 2008 to the end of March 2009.

PepsiCo's valuation ratios can be compared with other companies in the Processed & Packaged Goods industry.

OverallMarch 20093 months prior
12 months prior
Gauge Score (0 to 100)49

PepsiCo's first-quarter results were much better than we expect and can be attributed to good cost control.  Neverthess, the Growth and Profitability gauges are remain weak.

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