11 September 2009

PEP: Look Ahead to September 2009 Quarterly Results

The GCFR Overall Gauge of PepsiCo (NYSE: PEP) slipped from 48 of the 100 possible points to 44 in the 12 weeks that ended 13 June 2009.  This period was the second quarter of the company's fiscal 2009.  Our income statement and financial gauge analyses explained in some detail how the score was attained.

PepsiCo's GAAP earnings increased from $1.05 to $1.06 per diluted share in the second quarter.  Revenue was 3.2 percent less than in the same period last year; however, the decline was due to the strengthening of the U.S. dollar.  Revenue would have increased 5.5 percent had currency exchange rates remained constant.

We have now modeled PepsiCo's Income Statement for fiscal 2009's third quarter, which ended on 5 September.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce in October.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

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.

In August, after months of negotiations, PepsiCo reached agreements to acquire Pepsi Bottling Group, Inc. (NYSE: PBG) and PepsiAmericas, Inc., (NYSE: PAS), which are its two largest bottlers, for $7.8 billion.

The Food and Beverage industries are relatively less affected by economic slumps, but they are not immune to changing business conditions or consumer preferences.  In response, PepsiCo has cut recurring costs through workforce reductions and plant closures.  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.

Consumers, for some years now, have been shifting from carbonated beverages to bottled water, juices, and teas.  However, bottled water sales might now be slowing in response to economic and environmental concerns.  This did not stop PepsiCo from agreeing in August to acquire Amacoco, which is Brazil's largest distributor of coconut water.

Last year, PepsiCo and PBG acquired Russia juice-maker Lebedyansky.

Now, we are ready to look ahead.

PepsiCo's press release in July announcing second quarter results reaffirmed the guidance for 2009 that had been given in February:

2009 Guidance

[The] company reaffirms its full-year 2009 guidance for both net revenue and core EPS of mid- to high-single-digit constant currency growth over its 2008 core EPS of $3.68. The company estimates that foreign exchange, at current rates, would have roughly a 6 percent adverse impact to its full-year constant currency core EPS. ...  The company did not repurchase its shares in the first two quarters and does not anticipate repurchasing its shares until there is a resolution of the proposed transactions with The Pepsi Bottling Group, Inc. and PepsiAmericas, Inc.

Excluding the impact of its $1 billion discretionary pension contribution (approximately $640 million after-tax) cash from operating activities is expected to be about $7 billion. The company expects to invest about $2.1 billion in net capital spending.

The company’s 2009 guidance does not include the impact of the proposed transactions with The Pepsi Bottling Group, Inc. and PepsiAmericas, Inc.

To establish a Revenue target for the third quarter, we start with the company's guidance for annual Revenue growth, on a constant currency basis, in the "mid- to high-single digits."  This is suggestive of a range between 6 and 9 percent.

Although the currency guidance applies to the full year, we will assume the indicated -6 percent impact is also valid for the third quarter.  If true, PepsiCo's overall Revenue growth could be between 6 - 6 = 0 to 9 - 6 = 3 percent.  We will split the difference and pick 1.5 percent as our target.  Therefore, our Revenue estimate for the September 2009 quarter is 1.015 * $11.244 billion = $11.4 billion.

In the first half of the year, PepsiCo's Gross Margin was about 54 percent of Revenue.  If this margin is attained again in the third quarter, and our Revenue estimate is accurate, the Cost of Goods Sold would be (1 - 0.54) * $11.4 billion = $5.25 billion.

In the third quarter of the last five fiscal years, SG&A expenses averaged 34 percent of Revenue, with relatively little variation.  Therefore, our assumption for these costs is 0.34 * $11.4 billion = $3.9 billion.

We'll assume a $15 million charge for amortization of intangible assets.  This estimate is based on quarterly charges in the last couple of years.

These assumptions would lead to Operating Income, as we define it, of almost $2.3 billion.  If achieved, this figure would surpass the equivalent amount in the year-earlier quarter by 14 percent.  Note that this estimate does not include Productivity for Growth charges, mark-to-market commodity hedge costs, nor acquisition costs.

Bottler equity income will probably be down from last year's hefty amount because it is unlikely PepsiCo profited by selling shares in its bottling operations, as it had in the past.  Our $72 million estimate for equity income is the average of the first two quarters of the year.

A $100 million charge for net Interest Expense seems reasonable given recent history.  This would result in pretax income of $2.2 billion.

We're using a 26 percent effective income tax rate, which would result in a tax provision of $583 million.  The rate can be surprisingly volatile from quarter to quarter.

Rolling up these figures, we're looking for Net Income of $1.66 billion ($1.05/share).  In last year's third quarter, PepsiCo earned $1.58 billion ($0.99/share).

Please click here to see a full-sized, normalized depiction of the projected results next to PepsiCo's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long PEP at time of writing.

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