PepsiCo, Inc. (PEP) 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 (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.
When we analyzed PepsiCo after 2007's fourth-quarter and full-year results became available, the Overall gauge score dropped to a weak 23 points. The decline was the product of slowing income growth and a stock price that soared 21 percent in 2007. Of the four individual gauges that fed into the composite result, Profitability was the strongest at 12 points. Value was weakest at 0 points.
Now, with the available data from the March 2008 quarter, our gauges display the following scores:
- Cash Management: 8 of 25 (unchanged from December)
- Growth: 3 of 25 (down from 5)
- Profitability: 10 of 25 (down from 12)
- Value: 2 of 25 (up from 0)
- Overall: 23 of 100 (unchanged)
Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.
Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($M) | | March 2008 (actual | March 2008 (predicted) | (actual) |
| Revenue | | 8333 | 8000 | 7350 |
| Op expenses | | | | |
| | CGS | (3834) | (3680) | (3285) |
| | SG&A | (2934) | (2840) | (2635) |
| | Amortization, etc. | (12) | (15) | (11) |
| Operating Income | | 1553 | 1465 | 1419 |
| Other income | | | | |
| | Equity income | 70 | 100 | 74 |
| | Interest, etc. | (57) | (25) | (20) |
| Pretax income | | 1566 | 1540 | 1473 |
| Income tax | | (418) | (424) | (377) |
| Net Income | | 1148 | 1117 | 1096 |
| | | $0.70/sh | $0.68/sh | $0.66/sh |
| Shares outstanding | 1632 | 1640 | 1673 |
Revenue beat our estimate by 4.2 percent. We expected Revenue to exceed its value in the year-earlier quarter by 8.8 percent, and the actual increase was 13.4 percent. On a year-over-year basis, Revenue grew by 13.1 percent, which surpassed our 12.2 percent estimate. International operations, aided by the weak dollar, contributed mightily to the sales surge. Revenues at PepsiCo's three business units that operate outside North America grew by an average of 30 percent. Revenue at the three other units that operate in North America grew by 6.7 percent.
We predicted correctly that the Gross Margin would slip to 54.0 percent of Revenue in the first quarter because of rising raw material prices. The Cost of Goods Sold (CGS) was equal to 46 percent of Revenue.
We did almost as well with Sales, General, and Administrative (SG&A) expenses, which were 35.2 percent of Revenue, compared to our estimate of 35.5 percent. Amortization of intangible assets was $3 million less than we expected.
The greater-than-expected Revenue, with costs as predicted, enabled Operating Income, as we define it, to exceed the forecast value by 6.0 percent and to top the year-earlier value by 9.4 percent. PepsiCo indicated that "foreign currency [changes] contributed almost 3 percentage points to operating profit growth."
Bottling equity income can be erratic. The latest value fell below our unreliable prediction by $30 million (30 percent). Management attributed the decrease to "lower pre-tax gains on our sale of [Pepsi Bottling Group, Inc. ] PBG stock." Net Interest Expense was also $32 million more than we expected. In this case, the expense was greater than anticipated because of losses on investments used to hedge a deferred liability. Poor results for the two non-operating values (equity income and interest) nearly canceled out the amount Operating Income bested our prediction.
The Income Tax Rate was 26.7 percent, instead of the predicted 27.5 percent. The rate has been surprisingly volatile from quarter to quarter, and rate changes can have a significant effect on reported income. The lower rate helped Net Income beat our prediction by 2.8 percent.
Cash Management. This gauge remained at 8 points.
| March 2008 | 3 mos. ago | 12 mos. ago | |
| Current Ratio | 1.3 | 1.3 | 1.2 |
| LTD/Equity | 29.2% | 24.4% | 11.8% |
| Debt/CFO | 0.9 yrs | 0.6 yrs | 0.4 yrs |
| Inventory/CGS | 44.8 days | 42.7 days | 44.9 days |
| Finished Goods/Inventory | 47.0% | 47.0% | 48.8% |
| Days of Sales Outstanding (DSO) | 40.3 days | 37.5 days | 39.6 days |
| Working Capital/Market Capitalization | 2.0% | 1.9% | 1.1% |
| Cash Conversion Cycle Time | -45 days | -60 days | -48 days |
PepsiCo has taken on more debt, but the level is easily affordable. The debt is mostly likely used to fund capital spending and share repurchases. Inventory, something we watch very closely for signs of problems, is clearly under control. We know that a low and decreasing CCCT is one sign of cash management efficiency, but we've never had time to figure out if negative values are especially desirable or whether they invalidate the measurement.
Growth. This gauge decreased from 5 points in December to 3 points now.
| March 2008 | 3 mos. ago | 12 mos. ago | |
| Revenue growth | 13.1% | 12.3% | 9.4% |
| Revenue/Assets | 113% | 114% | 120% |
| CFO growth | 4.5% | 14.0% | 23.9% |
| Net Income growth | -1.4% | 0.3% | 40.8% |
Revenue has grown as the dollar has weakened, but Cash Flow and Net Income growth has decelerated or reversed direction. A major contributor to the drop in earnings is that the Income Tax rate increased from 19.0 percent to 26.1 percent in the last year. [One-time factors led to an abnormally low tax rate last year.]
Profitability. This gauge slipped from 12 points in December to 10 points now.
| March 2008 | 3 mos. ago | 12 mos. ago | |
| Operating Expenses/Revenue | 81.8% | 81.7% | 81.0% |
| ROIC | 25.8% | 26.1% | 32.1% |
| FCF/Equity | 26.1% | 26.1% | 29.3% |
| Accrual Ratio | 6.1% | 7.1% | -0.1% |
Operating expenses have edged up, but by very minor amounts. We're concerned that the Accrual Ratio is indicating that less of the company's Net Income is due to Cash Flow from Operations (CFO), and, therefore, more is due to changes in non-operational Balance Sheet accruals.
Value. PepsiCo's stock price slid from $75.90 to $72.20 during the first three months of 2008. The drop was only enough to increase this gauge from 0 to 2 points from December until March.
| March 2008 | 3 mos. ago | 12 mos. ago | |
| P/E | 20.6 | 22.1 | 18.4 |
| P/E to S&P 500 average P/E | 125% | 124% | 116% |
| Price/Revenue | 2.9 | 3.2 | 3.0 |
| Enterprise Value/Cash Flow (EV/CFO) | 17.8 | 18.3 | 16.4 |
PepsiCo's international operations have boosted Revenue, but other costs have prevented the higher sales from reaching the bottom line in a big way. This situation is reflected in the Overall Gauge score of 23 points. It's true that last year had more substantial non-recurring tax benefits, which skews the comparisons. We should also acknowledge that management is deftly handling increases in raw material costs, and they are returning profits to shareholders via share repurchases. Nevertheless, current financial results don't explain why PepsiCo shares are commanding a more significant premium to the market multiple.
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