PEP: Financial Analysis through Sept 2007 (Updated)

PepsiCo's (PEP) 10-Q filing to the SEC for the quarter that ended on 8 September 2007 included details that were not available in the preliminary financial results, which we analyzed previously. The additional data and minor restatements to earlier results were not significant enough to alter the gauge scores.

However, the values for some parameters used to calculate the gauges did change, albeit by small amounts. For the sake of accuracy and completeness, we are republishing the entire analysis report.

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 has made it more diversified. 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 June quarter, the Overall score was a good (for PepsiCo) 42 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 21 points. Value was weakest at 5 points.

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

• Cash Management: 13 of 25
• Growth: 23 of 25
• Profitability: 13 of 25
• Value: 3 of 25
  

• Overall: 39 of 100
  

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

($M)		Sept 2007 (actual)	Sept 2007 (predicted)	Sept 2006 (actual, restated)
Revenue		10171	9740	9134
Op expenses
	CGS	(4627)	(4383)	(4108)
	SG&A	(3467)	(3506)	(3129)
	Amortization	(15)	(40)	(41)
Operating Income		2062	1811	1856
Other income
	Equity income	218	220	204
	Interest, etc.	(36)	(20)	(12)
Pretax income		2244	2011	2048
Income Tax		(501)	(549)	(554)
Net Income		1743	1462	1494
		$1.06/sh	0.89/sh	0.89/sh

Revenue was 4.4 percent above our estimate and 11.4 percent greater than in the year-earlier quarter. One reason our estimate was low was that we extrapolated historical data that was subsequently restated upward. Nevertheless, PepsiCo's Revenue clearly beat expectations. We thought the Cost of Goods Sold (CGS) would be 45 percent of Revenue, and the actual value was 45.5 percent. The extra half percent might be due to higher raw material costs.

Sales, General, and Administrative (SG&A) expenses were 34.1 percent of Revenue, compared to our forecast of 36 percent. PepsiCo did a good job controlling these costs.

The net effect of the higher Revenue and lower expenses was Operating Income 13.9 percent above the forecast value.

Non-operating income was $18 million less than expected. The Income Tax Rate was 22.3 percent, instead of the predicted 27.3 percent. One reason for the lower rate was a $115 benefit related to the resolution of foreign matters. This benefit, which was unpredictable, went right to the bottom line. As a result, Net Income exceeded our prediction by a fabulous 19.2 percent.


Cash Management. This gauge held steady at June's 13 points.

The measures that helped the gauge were:

• LTD/Equity = 18.2 percent, up from 15.8 percent a year ago, but quite manageable
• Finished Goods/Inventory = 43.3 percent, down sharply from 47.7 percent in Sept 2006 (we're suspicious when inventory is piling up at the warehouse or on store shelves)
  
• Cash Conversion Cycle Time (CCCT) = -56 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 = 0.4 years, an insignificant level that compares to 0.6 years 3 and 12 months ago.
  

The measures that hurt the gauge were:

• Current Ratio =1.2; weaker than we like, but matching the 5-year median
• Inventory/CGS = 45.6 days, down from to 51.1 days 3-months ago, but up from 43.1 days 12 months ago.
• Days of Sales Outstanding (DSO) = 43.4 days, greater than the 41.8-day level one year earlier
• Working Capital/Market Capitalization = 1.5 percent, down from 2.1 percent.
  

The Inventory decrease from June confirmed our earlier view that the inventory increases in June merely signified preparations for the summer selling period. Output clearly was not piling up unsold.

Growth. This gauge increased from 21 points in June to 23 points.

The measures that helped the gauge were:

• Revenue/Assets = 116 percent, up from 107 percent in a year (sales efficiency is improving)
• Net Income growth = 26 percent (!) year-over-year, up from 25 percent.
• CFO growth = 25 percent year-over-year, up from -6 percent
  

Net income benefited greatly from a 11 percent drop in the income tax rate from 28 to 17 percent

The measure that hurt (slightly) the gauge was:

• Revenue growth = 8.6 percent year-over-year, down from 10.5 percent.
  

Profitability. This gauge held steady at the 13 points it achieved in June.

The measures that helped the gauge were:

• ROIC = 32 percent, up from 26 percent in a year
• FCF/Equity = 29 percent, up from 22 percent in a year.
  

The measures that hurt the gauge were:

• Accrual Ratio = +4.3 percent, down a speck from +4.4 percent in a year
• Operating Expenses/Revenue = 81.2 percent, essentially unchanged from 81.3 percent.
  

Value. PepsiCo's stock price rose from the end of June to the end of September from $64.85 to $73.26. Given the magnitude of the increase, it's not surprising the Value gauge, based on the more recent price, dropped to 3 points, compared to 3 points three months ago.

The measures that helped the gauge were:

• Enterprise Value/Cash Flow = 17.4, down from 19.7 in September 2006 and a 5-year median of 17.6
• P/E = 19.6, down from 22.5 one year ago and a median value of 23.2
  
• P/E to S&P 500 average P/E = 21 percent premium, lower than the five-year median premium of 28 percent.
  

The measures that hurt the gauge were:

• Price/Revenue ratio = 3.2, above the five-year median of 3.0.
  

The average P/E for the Non-alcoholic Beverages industry is currently a more expensive 23. The average Price/Revenue for the industry is currently 4.0.

Now at a solid (for PepsiCo) 39 out of 100 possible points, the Overall gauge had been trending up until giving back 3 points in the recent quarter. We've noticed an 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 correlate well (corr. coefficient = 0.62) with future stock price gains. On an operational basis, the company clearly had another excellent quarter, somewhat abetted by a one-time tax-related gain. PepsiCo shares are getting more expensive, compared to historic results; however, the shares are not as expensive as its peers in the Non-alcoholic Beverages industry.