24 July 2007

PEP: Financial Analysis through June 2007

We have analyzed PepsiCo's (PEP) financial statements, as reported in a 10-Q filed with the SEC, for the quarter that ended on 16 June 2007. The relatively minor changes between the formal financial statements and those in the preliminary press release didn't change the analysis results, nor our gauge scores.

PepsiCo is a leading global purveyor of beverages and snacks. The company is known for good management, steady growth, significant international exposure, and the defensive characteristics of the food and beverage industries. While famously locked in a battle with Coca-Cola for the soft-drink market, PepsiCo's snack food business results in a more diversified company. In the North American markets, the Frito-Lay division takes in more revenue and contributes more to operating profit than the Pepsi Bottling division.

When we analyzed PepsiCo after the March quarter, the Overall score was a good (for this company) 39 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at a powerful 23 points. The important Value gauge was weakest at 5 points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.


($M)
June 2007
(actual)
 June 2007
(predicted)
 June 2006
(actual)
Revenue
9607
 9323
8714
Op expenses




CGS (4342)
 (4196)
(3862)

SG&A (3295)
 (3356)
(3016)

Amortization (11)
 (52)
 (36)
Operating Income
1959 1719
1800
Other income




Equity income
 173
 133
161

Interest, etc.
 (15) (20)
(33)
Pretax income
2117 1832
 1928
Income tax
(560)
 (513)
 (553)
Net Income
1557 1319
1375


0.94/sh
 0.79/sh
0.81/sh






Revenue was 3 percent above our estimate. However, this overstates the revenue "surprise." We expected Revenue in the recently concluded quarter to be 8.4 percent greater than in the year-earlier quarter. However, the company restated the year-earlier revenue from $8.599 billion to $8.714 billion. If we had assumed 8.4 percent growth over $8.714 billion, our prediction would have been $9.446 billion. Actual revenues beat this recalculated prediction by 1.7 percent.

In addition, we thought the Cost of Goods Sold (CGS) would be 45 percent of Revenue, and the actual value was 45.2 percent. Sales, General, and Administrative (SG&A) expenses were 34.3 percent of Revenue, compared to our forecast of 36 percent.

The net effect of the higher Revenue, lower SG&A expenses, and $40 million less amortization expense was Operating Income 14 percent above the forecast value.

Non-operating income was $45 million greater than expected. The Income Tax Rate was 26.5 percent, instead of the predicted 28 percent. As a result, Net Income exceeded our prediction by 18 percent!


Cash Management. This gauge increased from 8 points in March to 13 points.

The measures that helped the gauge were:
  • LTD/Equity = 20.5%, up from 16.7 percent a year ago, but quite manageable
  • Finished Goods/Inventory = 44 percent, down from 49 percent last quarter
  • Cash Conversion Cycle Time (CCCT) = -46 days; we're not sure what to make of a negative value for this measure of efficiency, but it has to be good.
  • Debt/CFO = 0.6 years, an insignificant level that compares to 0.4 and 0.7 years 3 and 12 months ago, respectively.
The measures that hurt the gauge were:
The Inventory increase (something we watch closely) would worry us, except that increases in the June quarter are the norm. The reduction in the percentage of inventory that is product ready for sale confirms this view. Output was not piling up unsold.

Growth. This gauge decreased from 23 points in March to 20 points.

The measures that helped the gauge were:
  • Revenue/Assets = 114 percent, up from 107 percent in a year; sales efficiency is improving
  • Net Income growth = 38 percent (!), up from -3 percent in a year
  • CFO growth = 20 percent, up from -10 percent in a year
Net income benefited greatly from a drop in the income tax rate from 35.5 to 18.5 percent.

The measures that hurt the gauge were:

Profitability. This gauge held steady at 13 points from March to June.

The measures that helped the gauge were:
  • ROIC = 30 percent, up from 22 percent in a year
  • FCF/Equity = 27 percent, up from 22 percent in a year
The measures that hurt the gauge were:
The increasing Accrual Ratio tells us that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals.


Value. PepsiCo's stock price inched up over the quarter from $63.56 to $64.85. The Value gauge, based on the latter price, matched last quarter's 5 points three months ago.

The measures that helped the gauge were:
The measures that hurt the gauge were:
  • Price/Revenue ratio = 3.0, about the same as the five-year median of 3.1.
The average P/E for the Non-alcoholic Beverages industry is currently a more expensive 22. The average Price/Revenue for the industry is currently 3.7.


Now at a solid 42 out of 100 possible points, the Overall gauge has been steadily increasing.

We've noticed a strange anomaly with our gauge scores for PepsiCo. The figures never get very high and, therefore, make the company appear weak. However, the scores over a seven-year period (28 quarters) actually correlated well (corr. coefficient = 0.65) with future stock price gains. In other words, rising scores have presaged price increases; the gauges just don't seem to rise very high. The Overall Gauge peaked at 43 points in September 2002, when the stock price was in the mid $30s. Shares sold in the mid $40s a year later, and you know the rest of the story.
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