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Pepsi Beats on Earnings; Raises 2014 Returns


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PepsiCo, Inc.’s (PEP - Analyst Report) announced mixed fourth-quarter results, beating the Zacks Consensus Estimate for earnings but missing the same for revenues.

Also, the company increased 2014 cash returns by 35%, announced a new $5 billion productivity program along with its intention to retain the North American beverage business.

The food/beverage giant’s fourth-quarter 2013 core earnings per share of $1.05 beat the Zacks Consensus Estimate of $1.01 by about 4.0%. However, earnings declined 3.5% year over year as aggressive marketplace investments, currency headwinds and higher tax rates offset pricing and productivity gains.

Currency hurt the fourth-quarter earnings by 3.5%, slightly lower than management’s expectations of 4%. In constant currency terms, adjusted earnings were flat.

Core earnings exclude the impact of restructuring and integration charges and one-time benefit due to certain tax audit settlements. Including these factors, reported earnings per share were $1.12, up around 6% year over year.

Top-Line and Volume Growth

Total sales in the quarter improved 1.0% year over year to $20.12 billion. However, structural changes, mainly beverage re-franchising transaction in Vietnam, pulled down revenues by 1.0% higher than management’s expectations of 0.5%. Foreign exchange hurt revenue growth by 3.0%, in line with management’s expectation. Revenues fell shy of the Zacks Consensus Estimate of $20.292 billion.

Excluding these factors, revenues increased 4.1% on an organic basis. Higher pricing and strong snacks performance offset weaker growth in European and American beverages.

PepsiCo witnessed an effective net pricing gain of 4% in the quarter, same as the past two quarters. Volumes were flat in the quarter, slightly better than a decline of 1% in the last quarter.

Both snacks and beverages showed positive organic volume growth with snacks growing 3% and beverages up 1.0%.

The American snacks businesses, especially the Frito-Lay North America and Latin American segments, once again posted strong results in the quarter. Organic volume of the American snacks segment increased 3%, gaining from successful innovations and increased brand building investments. Organic snacks volumes grew 2% in Europe and 5.5% in developing and emerging markets.

Despite growing 7.0% in developing/emerging countries, organic beverage volumes declined 2% in both the Americas and 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.

Concurrent with the fourth quarter results, management announced that it intends to retain the American beverage business as it was in the best interests of the company. Previously, the company had announced that it was looking for structural alternatives to turn around this business.

Margins Improve

Core constant currency operating profit improved 1.0% to $2.52 billion in the quarter. Core operating margins grew 37 basis points (bps) as productivity and pricing gains offset headwinds from higher operating costs, incremental investments and unfavorable mix. As expected, core effective tax rate of 28.2% was 150 bps above the year-ago levels.

In the second quarter, the company announced an incremental investment program. As part of the program, the company is stepping up investments in advertising, marketing and R&D to further strengthen its brands and to accelerate product innovations. As part of the plan, the company is boosting in-store merchandising capabilities, improving the effectiveness of go-to-market systems in international markets and identifying new productivity projects. Incremental marketplace investments totaled $56 million pre-tax in the fourth quarter.

Annual Results

In fiscal 2013, the company witnessed 1.0% increase in revenues to $66.42 billion, slightly missing the Zacks Consensus Estimate of $66.55 billion. Organically, revenues grew 4.0%, in line with management expectation of mid single-digit increase.

Core earnings per share of $4.37 beat the Zacks Consensus Estimate of $4.35 by 0.5%.

Core earnings grew 9% year over year on a constant currency basis, higher than management’s expectation of 7% driven by strong operating margins and lower taxes.

New restructuring Plan

The company announced a new 5-year restructuring plan that will aim to generate annual productivity savings of $1 billion from 2015 to 2019. The savings are expected to come from improved efficiency through manufacturing automation, closure of certain manufacturing facilities, re-engineering go-to-market systems in developed markets, expanding shared services and simplifying organization structures.

Under its current Productivity Plan, the company recorded $2 billion as productivity savings through 2013 and intends to generate another $1 billion in 2014.

2014 Outlook In-Line with Long Term Targets

In 2014, Pepsi expects core constant currency earnings per share to increase 7% year over year from $4.37 per share reported in 2013. The target is in line with management’s long-term goal of high single-digit core constant currency earnings growth.

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.

Currency is expected to hurt 2014 earnings per share and revenues by 4% and 3%, respectively.

Commodity inflation is expected in the low single-digit range in 2014. Productivity savings are expected to amount to $1 billion in 2014, which will be used to offset headwinds from cost inflation and thereafter, reinvest in the business. The core tax rate is expected to be approximately 25% for 2014, slightly lower than 2013. Moreover, interest expenses are expected to be higher than 2013 due to increased debt balances.

Increased Dividend/Share Buybacks in 2014

Also, management plans to increase cash returns to shareholders in 2014 by 35% to $8.7 billion through significant hikes in dividends and share repurchases. Management announced a 15% increase in 2014 annual dividend. It will now pay a dividend of $2.62 annually, up from $2.27 per share to take effect from Jun 2014. Moreover, Pepsi intends to buyback shares worth $5 billion in 2014.

Pepsi carries Zacks Rank #3 (Hold). Rival, The Coca-Cola Company (KO - Analyst Report) is due to report its fourth-quarter/fiscal 2013 results next week. Coca-Cola’s bottler, Coca-Cola Enterprises, Inc. (CCE - Analyst Report) reported a mixed quarter, beating the Zacks Consensus Estimate for earnings but marginally missing the same for revenues. Another beverage company, Dr Pepper Snapple Group, Inc. (DPS - Analyst Report) also had a mixed quarter, as pricing and productivity gains helped it beat the Zacks Consensus Estimate for earnings despite missing revenue expectations.

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