15 December 2009

PEP: Look Ahead to December 2009 Quarterly Results

PepsiCo, Inc., (NYSE: PEP) earned $1.09 per share in the 12 weeks that ended 5 September, up from $0.99 last year.

In October, we examined PepsiCo's Income Statement for the September quarter and compared the entries on each line to our "look-ahead" estimates.  We later performed a financial gauge analysis of PepsiCo, which determined that the GCFR Overall gauge rose from 44 of the 100 possible points to 50.

We have now modeled PepsiCo's Income Statement for the super-sized, 16-week quarter that will end on 26 December 2009.  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 February 2010.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about PepsiCo and the business environment in which it is currently operating.

PepsiCo, Inc., is a leading global purveyor of beverages and snacks.  The company is well regarded for good management, steady growth, and significant international exposure.  The Food and Beverage industries are considered defensive investments because they are relatively less affected by economic slumps.

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.

Consumers, especially in the U.S., have been shifting from carbonated beverages and sports drinks like Gatorade to bottled water, tap water, juices, and teas.  Slower beverage sales did not stop PepsiCo from agreeing in August to acquire Amacoco, Brazil's largest distributor of coconut water.

In August 2009, PepsiCo reached agreements to acquire Pepsi Bottling Group, Inc. (NYSE: PBG) and PepsiAmericas, Inc., (NYSE: PAS), which are its two largest bottlers.  These transactions, for $7.8 billion, are expected to close in the first quarter of 2010.

The two bottlers now distribute some Dr. Pepper Snapple Group (NYSE: DPS) products in certain regions.  Following the acquisition, PepsiCo will manufacture and distribute these products in the same territories, in accordance with a new 20-year agreement.  PepsiCo will pay DPS $900 million to put this arrangement into effect.

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 and smaller charges in fiscal 2009.

Now, we are ready to look ahead to December's results.

PepsiCo's press release on 8 October 2009 announcing third-quarter results reaffirmed the guidance for 2009 that had been given in February:

The company reaffirms its full-year 2009 guidance for both net revenue and core EPS of mid-to high-single-digit core constant currency EPS growth off of fiscal 2008’s core EPS of $3.68. Based on current spot rates, foreign exchange translation would represent a mid-single-digit percentage point adverse impact on the company’s full-year, core constant currency EPS. Because the company expects to close on the proposed acquisitions of PBG and PAS in late 2009 or early 2010, the company’s 2009 guidance does not include the impact of the proposed acquisitions. The company did not repurchase any of its shares in the third quarter and does not expect to repurchase any shares in its fourth quarter.

[emphasis added]

This guidance was updated when PepsiCo announced the agreement with Dr. Pepper Snapple.

In its fiscal 2009 fourth quarter, PepsiCo has begun to step-up investments in targeted areas that will support improved growth and profitability in 2010 and beyond. For example, PepsiCo is making infrastructure investments in developing markets, such as China, to drive increased penetration and distribution of both carbonated and non-carbonated beverages. It has also increased investments in differentiated science-based R&D to accelerate the company’s health and wellness transformation.

For fiscal 2009 PepsiCo expects constant currency net revenue to be up about five percent. The company also expects division operating profit to increase about six to seven percent and EPS to increase about five to six percent, each in core constant currency, off of its fiscal 2008 core EPS of $3.68. Based on current spot rates, foreign exchange translation would represent about a five percentage point adverse impact to PepsiCo’s full-year, core constant currency EPS.

[emphasis added]

Note that guidance for Revenue growth for the year changed from a "mid-to high-single-digit" percentage rate to "about five percent." Similarly, the guidance for EPS growth changed to "five to six percent."  These growth rates exclude the effect of currency conversion rate changes that are likely to offset the core growth.

With five percent core Revenue growth and a five percent adverse effect due to currency translations, the latest guidance implies that reported Revenue for fiscal 2009 will be about the same as the $43.25 billion in fiscal 2008. 

In the first three quarters (36 weeks for PepsiCo) of fiscal 2009, Revenue was $29.94 billion.  Therefore, fourth-quarter Revenue should be about $43.25 billion minus $29.94 billion = $13.31 billion.

PepsiCo's Gross Margin in the most recent three quarters was 53.9 percent of Revenue.  The margin in the fourth quarter is typically about 1 percent less.  Given the additional investments the company is making, we are selecting 52.5 percent as our target for the current quarter.   If true, the Cost of Goods Sold would be (1 - 0.525) * $13.3 billion = $6.33 billion.

The fourth-quarter SG&A expense is usually around 39 percent of Revenue, give or take a couple of percent.  We're assuming it will be a little less, about 38 percent because of previous cost-cutting actions.  This leads to an estimate for these costs of 0.38 * $13.3 billion = $5.1 billion.

We're also estimating a $20 million charge for amortization of intangible assets, based on historical data.

These assumptions lead to Operating Income, as we define it, of $1.9 billion.  This figure is 57 percent more than the equivalent amount in the December 2008 quarter, which included large special charges.  Note that this estimate does not include Productivity for Growth charges, mark-to-market commodity hedge costs, nor acquisition costs.

We are assuming that Bottler equity income will offset net Interest Expense.  These figures can be surprisingly volatile from quarter to quarter.

We're using a 25 percent effective income tax rate, which would result in a tax provision of $478 million. 

Rolling up these figures, we're looking for Net Income of $1.4 billion ($0.90/share).  In last year's fourth quarter, PepsiCo earned $719 million ($0.46/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.  No position in any other security mentioned.

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