Pepsi’s revenue grew by 1.3% on an organic basis, reaching $23.3bn in the third quarter, ignoring currency impacts. Growth was driven entirely by higher prices as volumes of both food and drink fell. Quaker Foods continues to see the biggest decline in volumes due to product recalls after contamination concerns.
Underlying operating profit rose at a faster pace of 6% to $4.2bn, as “strong cost controls” helped improve profitability.
Free cash flow has worsened from $5.2bn to $3.5bn over the first three quarters, largely due to the timing of payments. Net debt rose from $34.1bn to $37.0bn over the same period.
Full-year organic revenue growth guidance has been downgraded for the second time in as many quarters, with management now expecting low single-digit growth (previously around 4% growth). Earnings per share (EPS) guidance of at least $8.15 remains unchanged.
The shares fell 1.2% in pre-market trading.
Our view
Pepsi’s third quarter was another weak one on the revenue front. Price hikes are just about doing enough to keep organic growth moving in the right direction. But a second revenue downgrade in as many quarters means 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, but nothing is guaranteed.
Unlike rival Coca-Cola, it doesn't limit itself to soft drinks. Pepsi's products include snack brands such as Walkers crisps and Doritos. Pepsi’s wide range of top-quality brands can help soften the blow if any one brand underperforms, which is exactly what we’ve seen recently. A high-profile recall of Quaker Oats products after concerns that they could be contaminated with salmonella bacteria continues to cost the group. But things could be much worse if other blockbuster brands weren’t on hand to pick up some of the slack.
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 $37.0bn, 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 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 in the near term, and revenue and profit growth along with it.
Pepsi's valuation sits a little below its long-term average. But trading at nearly 20 times forward earnings means there’s still a lot of pressure to deliver growth. The focus should be on the long term and investors could be faced with further possible disappointment in the near term.
Environmental, social and governance (ESG) risk
The food and beverage industry tends to be medium-risk in terms of ESG though some segments like agriculture, tobacco and spirits fall into the high-risk category. Product governance is a key risk industry-wide, especially in areas with strict quality and safety requirements. Labour relations and supply chain management are also industry-wide risks, with other issues varying by sub-sector.
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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