25 July 2009

PEP: Gauge Scores for the June 2009 Quarter

In an earlier post, we examined PepsiCo's (NYSE: PEP) Income Statement for the 12 weeks that ended 13 June 2009 and compared the figures to our "look-ahead" estimates.  PepsiCo's GAAP earnings increased from $1.05 to $1.06 per diluted share in this second quarter of the fiscal year. 

We have since mined the financial statements in PepsiCo's 10-Q for the quarter to update the metrics we use to assess Cash Management, Growth, Profitability and Value.  This post reports on these metrics and the Financial Gauge scores.

In summary, PepsiCo's latest GCFR gauge scores are as follows:

  • Overall: 44 of 100 (down from 48)

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash Management Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Current Ratio 1.3 1.4 1.4 1.3
LTD/Equity 58.6% 76.5% 36.3% 25.6%
Debt/CFO (years) 1.4 1.5 0.9 0.8
Inventory/CGS (days) 53.5 45.7 51.4 44.9
Finished Goods/Inventory 41.5% 42.6% 45.3% 46.3%
Days of Sales Outstanding (days) 46.2 39.8 44.9 40.5
Working Capital/Invested Capital 14.9% 14.9% 16.1% 12.3%
Cash Conversion Cycle Time (days) -43.5 -48.5 -41.0 -54.0
Gauge Score (0 to 25) 12 13 13 9

PepsiCo's capital structure has become much more leveraged over the last few years.  Long-term debt expanded from $3 billion in September 2007 to over $9 billion earlier this year.  The debt has been used for acquisitions and share repurchases.   However, in the last three months PepsiCo trimmed $1 billion of debt from the total, bringing it down to $8.2 billion.  This action is reflected in the recent decrease in the Long-term debt to Equity ratio (from 76.5 percent to 58.6 percent) and, to a less extent, in the Debt to Cash Flow from Operations ratio.

Inventory changes, which can signal improving or worsening business conditions, increased substantially in the second quarter.  We would ordinarily consider the rise to be worrisome, but a check of the record indicates that PepsiCo always builds up inventory in the second quarter to meet the rising demand for cool beverages and snack in the warm summer.  The decrease in the ratio of finished goods in the inventory is consistent with this view.  The company has bought commodities in anticipation of future sales; output does not appear to be piling up unsold.

The increase in Days of Sales Outstanding is also typical for the June quarter.  It probably reflects expected seasonal sales growth.  We will keep an eye on this metric to make sure it is not indicating easier payment terms (to stimulate slack demand).

Growth Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Revenue growth 2.5% 6.7% 14.0% 9.0%
Revenue/Assets 116.0% 122.1% 121.7% 114.5%
Operating Profit growth 10.1% 10.0% 11.1% 5.6%
CFO growth -11.4% -9.0% 12.4% 10.3%
Net Income growth -12.9% -10.0% -1.9% 6.6%
Gauge Score (0 to 25) 1 1 14 11
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.
The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

Revenue is growing at a slower rate, but Cash Flow and Net Income are faring even worse.  Operating profit, which excludes special charges and non-operating items, and which we average over a longer time period, is showing more staying power.

The strengthening of the dollar has steepened declines caused by the weak economy and restructuring activities.   

Special factors, most notably a "discretionary" $1 billion pension plan contribution, have affected PepsiCo's results. 

Profitability Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Operating Expenses/Revenue 83.6% 83.7% 81.8% 81.7%
ROIC 25.5% 26.4% 29.4% 29.3%
Free Cash Flow/Invested Capital 19.7% 19.2% 23.7% 24.4%
Accrual Ratio 7.1% 6.1% 2.9% 4.5%
Gauge Score (0 to 25) 11 11 12 13

Operating Expenses as a percentage of Revenue have crept up (with the price of agricultural commodities) and have negatively effected earnings and cash flow returns on capital.  Nevertheless, these returns are remain admirable.

The recent increase in the Accrual Ratio, which can suggest diminished earnings quality, indicates that less the company's Net Income is due to Cash Flow from Operations (CFO).  However, this change seems to be more an artifact of the pension plan contribution than anything more worrisome.

Value Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
P/E 16.9 15.8 17.5 20.3
P/E vs. S&P 500 P/E 0.8 0.8 1.0 1.2
PEG 1.7 1.6 1.6 1.7
Price/Revenue 2.0 1.9 2.5 2.9
Enterprise Value/Cash Flow (EV/CFO) 14.6 14.2 15.0 16.4
Gauge Score (0 to 25) 14 16 10 5

The value metrics came under pressure as PepsiCo's stock price increased from $51.48 to $54.96 during months of April, May, and June.  However, several of these metrics, which can be compared with other companies in the Processed & Packaged Goods industry, remain modestly attractive relative to historic norms.

Overall Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Gauge Score (0 to 100) 44 48 47 37

PepsiCo's gauge scores are treading water.  Yet, we remain optimistic about the company.  The dollar will become less of a drag on results, organic growth will resume when the economy recovers, Productivity for Growth cost-cutting measures will have long-term benefits, as will recent acquisitions.  Sales of Gatorade might even begin to grow again after a difficult period!

A major unknown is the outcome of PepsiCo's April 2009 offer to buy the shares it does not already own in Pepsi Bottling Group, Inc. (NYSE: PBG) and PepsiAmericas, Inc., (NYSE: PAS). 

Full disclosure: Long PEP at time of writing.

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