Pepsi’s revenue grew by 1.9% on an organic basis, reaching $22.5bn in the second quarter, ignoring the impact of exchange rates. Growth was driven by higher prices, as drink volumes remained flat and food volumes declined by 2.0%. Quaker Foods saw the biggest decline, with volumes down 17%.
Underlying operating profit rose 7% to $4.1bn. Higher prices and productivity savings helped improve profitability.
Free cash flow worsened from an inflow of $0.6bn to an outflow of $0.3bn due to lower cash generation and higher levels of re-investment in the business. Net debt rose from $34.1bn to $38.3bn since the last year-end.
Full-year organic revenue growth expectations have been downgraded from “at least” 4% to just 4%. Earnings per share (EPS) guidance of at least $8.15 remains unchanged.
The shares fell 2.2% in pre-market trading.
Our view
Pepsi’s second quarter was another weak one on the revenue front, with organic growth stalling to low single digits. Moderate price hikes have been enough to offset falling food volumes for now. But with a small downgrade to full-year revenue expectations, Pepsi doesn’t expect growth to ramp up too much in the near future.
Cost-cutting initiatives have continued at pace though, helping to offset some of the impacts of lower volumes and keeping profits moving higher. That's impressive but remember, cost cuts are more like a plaster than a longer-term treatment.
Looking ahead, we anticipate easing cost inflation, which should slow the rate of price hikes and revive some demand for Pepsi's products. Growth from a more sustainable mix of price and volume would be welcome.
Longer term, we're not too worried. Pepsi boasts a wide range of top-quality brands. And unlike rival Coca-Cola, it doesn't limit itself to soft drinks. Pepsi's products include snack brands such as Walkers crisps and Doritos.
But in the short term, it’s these food brands that are currently weighing down Pepsi’s overall performance. A high-profile recall of Quaker Oats products after concerns that they could be contaminated with salmonella bacteria has cost the group.
It’s also worth noting that Pepsi's business model varies considerably by region. It'll manufacture products in some markets, and in others, it hands over almost complete control to a licensing partner - such as Britvic in the UK. On the one hand that makes Pepsi more capital intensive thanks to investments in factories and production equipment, increasing risk, but it's also allowed manufacturing processes to benefit from scale.
At $38.3bn, or just over two times expected cash profits (EBITDA), net debt is higher than we’d like. It’s not cause for concern at the moment, but we’d hope to see this start to come down again, especially as interest rates now look set to remain higher for longer, which increases the cost of rolling this debt over.
Overall, we consider Pepsi's variety of brands and history of strong execution a real bonus. But with volumes moving in the wrong direction, we're likely to see the rate of price hikes slow this year, and revenue and profit growth along with it.
Pepsi's valuation sits a little below its long-term average. But trading at 19.3 times forward earnings puts heavy expectations on its shoulders - meaning the shares could still be sensitive to stock market fluctuations or earnings disappointments. Right now, there are other names in the sector that look more attractive to us.
Environmental, social and governance (ESG) risk
The Food and Beverage industry is medium risk in terms of ESG, with some subsectors - like agriculture, tobacco and spirits - falling into the high-risk category. Product governance is an area of concern industry wide due to strict quality and safety regulations and incoming environmental regulations. Other risks vary by sub-industry, but human capital, community relations and resource use tend to impact most companies in this sector either directly or through their supply chains.
According to Sustainalytics, Pepsi’s management of ESG risk is strong. The group has strong anti-bribery and adequate human rights policies in place. Despite this, Pepsi is involved in significant human rights issues within its supply chains. Pepsi is also exposed to food safety issues that could result in customer health impacts and associated lawsuits which could potentially damage the brand and lead to financial repercussions.
PepsiCo key facts
All ratios are sourced from Refinitiv, based on previous day’s closing values. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn’t be looked at on their own – it’s important to understand the big picture.
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