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After a solid first quarter, PepsiCo Inc. (PEP - Analyst Report) reported strong second-quarter earnings results beating both the Zacks Consensus Estimate as well as the year-ago results. The food and beverage giant also delivered positive top-line growth and strong margins while retaining its 2013 outlook.

Earnings Discussion

PepsiCo’s second-quarter 2013 core earnings per share of $1.31 improved 17% from the year-ago levels driven largely by price increases and productivity gains from restructuring activities. However, the core earnings included a net gain of 7 cents per share from refranchising activities in Vietnam. Excluding this Vietnam gain, earnings were $1.24, which still beat the Zacks Consensus Estimate of $1.19 per share by 4.2%. Earnings grew 19% on a constant currency basis.

Core earnings excluded the impact of mark-to-market adjustments on commodity hedges and restructuring and integration charges. Including these factors, reported earnings per share were $1.28, up 36%.

Top-Line and Volume Growth

Total sales in the quarter improved 2% year over year to $16.81 billion. Structural changes, mainly beverage re-franchising transaction in China and Vietnam pulled down revenues by almost 1%, in line with managements’ expectation. Foreign exchange hurt revenue growth by 1.5%, less than managements’ expectation of 2%. Revenues also beat the Zacks Consensus Estimate of $16.74 billion.

Excluding these factors, revenues increased 4.2% on an organic basis. Higher pricing, strong snacks performance, improvement in Europe and another quarter of healthy growth in emerging and developing markets drove organic revenue growth. PepsiCo is boosting its existing brands and categories with stepped-up marketing and innovations which is driving market share gains.

Pepsi witnessed an effective net pricing gain of 4% in the quarter, better than first quarter’s 3%. Volumes were, however, flat in the quarter, slightly worse than last quarter’s 1% growth.

Both snacks and beverages showed positive organic volume growth with snacks growing 3% and beverages up 1.5%.

The American snacks businesses, especially the Frito-Lay and Latin American segments, once again did well in the quarter. Organic volume of the American snacks segment increased 2%, gaining from successful innovations and increased brand building investments. Organic snacks volumes grew 3% in Europe and 6% in Asia, Middle East & Africa (AMEA).

Though the organic beverage volumes grew a strong 9% in AMEA, the American beverage business continued to be sluggish and volumes declined 3.5%. Beverage volumes were flat in Europe.

Pepsi’s American beverage business has been consistently delivering sluggish results, especially the colas. Changing consumer preferences, increasing health consciousness, rising obesity concerns, possible new taxes on sugar-sweetened beverages and growing regulatory pressures are affecting the company’s carbonated beverage sales. PepsiCo has increased marketing investments and is driving package and product innovation to boost its American beverage business.

Margins Impressive

Core gross margins expanded 120 basis points (bps) in the quarter driven by strong pricing. Core constant currency operating profit improved 11% in the quarter despite a 13% increase in advertising and marketing costs. Solid top-line growth and productivity savings from its restructuring program drove profits in the quarter.  Importantly, the Vietnam gain added 3% to operating profit growth. Core operating margins grew 120 bps.

2013 Outlook Retained

With the strong results in the first half, management is now confident of meeting its 2013 targets. PepsiCo continues to expect core constant currency earnings to increase in 2013 by 7% from 2012 core earnings of $4.10 per share.

However, the guidance now incorporates the second-quarter Vietnam gain which was previously not included. The Vietnam gain is expected to offset higher-than-previously expected headwinds from currency and increased marketing investments. Currency headwinds are expected to hurt 2013 earnings by 2%, higher than prior expectations of 1%.

The target is in line with management’s long-term goal of high single-digit core constant currency earnings growth. Price/mix is expected to be a tailwind in the year.

Excluding headwinds from currency and structural changes, organic revenues are expected to grow in the mid single-digit range, also in line with the long-term targets. The structural changes in China and Vietnam as well as currency headwinds are expected to pull down organic revenues by 1% each.

Commodity inflation is expected to be in the low single-digit range in 2013.  The company expects its advertising/marketing expense to increase at a rate equal to or higher than revenue growth. The core tax rate is expected to be approximately 27% for 2013.

PepsiCo plans to reinvest any excess earnings to support brand building, innovation and improve productivity, especially in the U.S. Productivity savings are expected to amount to $900 million in 2013 which will be used to offset headwinds from cost inflation and thereafter, reinvest in the business.

PepsiCo currently carries a Zacks Rank #3 (Hold). The quarterly results come a week after activist investor, Nelson Peltz, announced plans to push Pepsi to take over food giant Mondelez International, Inc. (MDLZ - Analyst Report) and then spin-off its underperforming beverage business. The strong results may help Pepsi to fend off pressure from Peltz.

Rival, The Coca-Cola Company (KO - Analyst Report) reported weak second-quarter results, barely meeting the Zacks Consensus Estimate for earnings but missing the revenue estimate. Another beverage company, Dr Pepper Snapple (DPS - Analyst Report) reported sluggish second quarter results today; meeting the Zacks Consensus Estimate for earnings but missing the same for revenue

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