12 October 2009

PEP: Financial Gauge Analysis for the September 2009 Quarter

In a previous article, we examined PepsiCo's (NYSE: PEP) Income Statement for the 12 weeks that ended 5 September 2009, and we compared the figures on each line to our "look-ahead" estimates.  PepsiCo's GAAP earnings increased from $0.99 to $1.09 per diluted share in the third quarter of the fiscal year. 

We have since analyzed 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 associated financial gauge scores. 

Some background information about PepsiCo and the business environment in which it is currently operating can be found in the beginning of our look-ahead.

In summary, PepsiCo's latest GCFR gauge scores are as follows:
The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash ManagementSep 2009Jun 2009Sep 20085-Yr Avg
Current Ratio1.
Debt/CFO (years)
Inventory/CGS (days)50.453.546.545.3
Finished Goods/Inventory41.1%41.5%43.5%46.1%
Days of Sales Outstanding (days)46.946.244.840.7
Working Capital/Invested Capital15.8%14.9%7.4%12.3%
Cash Conversion Cycle Time (days)-50.9-43.5-45.1-53.6
Gauge Score (0 to 25)15121110

Long-term Debt had expanded from $3 billion as recently as September 2007 to more than $9 billion earlier this year.  PepsiCo used the some of the funds obtained from the added debt for acquisitions and share repurchases.

In a prudent step, the debt has recently been trimmed to $7.4 billion.  When combined with an increased Shareholders' Equity, now $15.3 billion, the Long-Term Debt to Equity ratio is much lower than it was 6 months ago.

Debt may, however, resume an upward trajectory when the company completes its bottler acquisitions.

The Cash Management score was also helped by the decrease in Debt relative to Cash Flow from Operations and the increase in Working Capital relative to Invested Capital.

Changes in the amount of Inventory on hand can signal improving or worsening business conditions.  In this case, Inventory at the end of the third quarter was lower (a good thing) than at the end of the second quarter.  This is expected because PepsiCo always builds up inventory in the spring to meet the rising demand for cool beverages and snacks in the summer.  However, the increase in Inventory over the last 12 months (to eliminate seasonal factors) as a percentage of Cost of Goods Sold suggests that sales have been softer than the company had anticipated.

The increase in Days of Sales Outstanding might be hinting that the company is giving its suppliers easier payment terms to stimulate slack demand.

GrowthSep 2009Jun 2009Sep 20085-Yr Avg
Revenue growth-0.5%2.5%13.7%8.1%
Operating Profit growth9.3%10.1%10.4%6.9%
CFO growth5.0%-11.4%-8.0%11.4%
Net Income growth-7.7%-12.8%-8.4%9.4%
Gauge Score (0 to 25)411010
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 and Net Income were both less in the last 12 months than in the previous year.  An erstwhile strengthening of the dollar exacerbated 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.

More constructively, Cash Flow from Operations perked up nicely in the last quarter, which enabled the trailing-year total to exceed its previous result by 5 percent.

Operating profit, which excludes special charges and non-operating items, and which we average over a longer time period, is showing some staying power.

ProfitabilitySep 2009Jun 2009Sep 20085-Yr Avg
Operating Expenses/Revenue82.9%83.6%82.4%81.7%
Free Cash Flow/Invested Capital21.9%19.7%19.8%25.6%
Accrual Ratio1.6%7.1%7.4%4.3%
Gauge Score (0 to 25)14111113

Operating Expenses as a percentage of Revenue had been rising, but the expense ratio seems now to be edging back down towards a more normal value. 

Higher expenses have sapped some strength from the ROIC and the Free Cash Flow return on capital.  The recent improvements in these two ratios helped the gauge score modestly in the current quarter.

The big drop in the Accrual Ratio (lower is better) may be the best news, as it suggests improved earnings quality.  Simply stated, more of the company's Net Income was due to Cash Flow from Operations.  Since Cash Flow was reduced earlier this year for the pension contribution, the decline in the Accrual Ratio is especially encouraging.

ValueSep 2009Jun 2009Sep 20085-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)14.414.718.617.3
Gauge Score (0 to 25)121446

Although PepsiCo's 12-week "quarter" ended on 5 September, the ratios in the Value table above were calculated using the respective month-end share prices.

During the July-to-September period, the price per share increased from $54.96 to $58.66.  This rise shaved a couple points off the most recent Value gauge score.  However, current valuation ratios are, in the whole, more appealing now than they were 12 months ago.

Readers might want to compare PepsiCo's value metrics to those of other companies in the Processed & Packaged Goods industry.

OverallSep 2009Jun 2009Sep 20085-Yr Avg
Gauge Score (0 to 100)50443237

We often see the Value gauge leading the Overall score higher.  However, in this case, the three other category gauges all rose while the Value gauge gave back a couple of points.

The 50-point Overall gauge score is the highest we have calculated for PepsiCo.  Please remember that it was calculated using a $58.66 share price, and the shares are now trading a bit over $60.  (We don't make trading recommendations, but we would wait to see if the price settles down before adding to a position.)

We expressed some optimism about the company three month ago.  The now-weakening dollar will become less of a drag on non-U.S. results, the economy will (albeit slowly) recover, and Productivity for Growth cost-cutting measures will have long-term benefits.  Sales of Gatorade might even begin to grow after a difficult period!

A major unknown is how well the PepsiCo will integrate Pepsi Bottling Group, Inc. (NYSE: PBG) and PepsiAmericas, Inc., (NYSE: PAS).  The company reported it is "on-track with its plans to acquire" its major bottlers, in transactions are expected to close later this year or early in 2010.  PepsiCo announced last Friday that it will refile certain paperwork to give the Federal Trade Commission an additional 30 days to review these two deals.

Full disclosure: Long PEP at time of writing.

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