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As usual, the earnings season opened with the Q3 figures for Pepsi shares, and although shares like Pepsi have no place in my portfolio, I was also looking forward to the figures with excitement. Will customers continue to remain loyal to branded products in times of sharply rising prices? Spoiler: In some regions, that's not the case, and yet the results are in Pepsi's favor.
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Expectations exceeded all along the line
I was completely surprised by Pepsi's quarterly figures and had no prior expectations. Measured against this, I have to attest to the company that they delivered across the board and significantly exceeded analyst estimates. Instead of the expected $20.72 billion, they came in at $21.97 billion. A year-over-year (YoY) growth of 8.8%. Earnings per share were $1.95 instead of the expected $1.85, representing growth of 22% YoY.
Organic growth amounted to 16%. Pepsi defines organic growth as the increase in sales adjusted for special effects. As is well known, I am not a fan of this kind of calculation service, but in this case I agree with the company, as it sharpens the focus on the actual operational strength of the company.
Thus, sales were adjusted for currency effects, which were mainly due to the strong dollar and the sale of Juice Brands. The guidance for the full year also relates to organic growth. Here, Pepsi now assumes 12% instead of 10% sales growth. The same applies to "core EPS", i.e. adjusted earnings per share. Here, the company now expects 10% instead of 8%.
Pepsi successfully passes on higher prices
However, it is interesting to see how the increase came about, especially in organic sales. For Q3, year-over-year price increases had a positive effect of 17%, while volume had a negative effect of 1%. So Pepsi sold less product, but at a much more expensive price. So price elasticity is working par excellence for the company. This was also emphasized by CEO Ramon Laguarta in the subsequent earnings call. Apparently, there is definitely a brand awareness among customers that allows Pepsi to pass on price increases to the company's advantage even in this situation.
Europe is particularly striking in this respect. There, increased prices had a positive effect of 24 % on sales, while the decline in sales had a negative effect of 10%. Here, it appears that some customers did opt for lower-priced products. Overall, however, this also shows that Pepsi is able to draw an advantage from its pricing measures, as the higher prices far more than compensate for the decline in demand.
However, it should be noted that this sales development is not necessarily sustainable. This was also the focus of the question posed by the Morgan Stanley analyst during the earnings call. Whether it was already apparent in Q4 that the strong growth was weakening. In response, Pepsi CFO Hugh Jonston emphasized that the long-term target for organic growth is 4-6 %, but that they are very happy with the current approach and will strive for the upper end of the guidance. Translated for me, that means Pepsi will continue to push the price margins. However, CEO Ramon Laguarta then put the brakes on expectations once again: 16% organic growth is an absolutely exceptional quarter and not a sustainable performance.
Solid cash flow
There are some special effects to note in the cash flow for the first 3 quarters. Due to the war in Ukraine, Pepsi had taken non-cash write-downs, as this is already having an impact on the company's operations and will continue to do so in the future.
In addition, it should be noted that shifts in working capital in particular, i.e. inventory, accounts payable/receivable, etc., had a negative impact on operating cash flow. These shifts are usually short-lived for a stock like Pepsi and then reverse, so I would disregard them in the calculation.
As usual, we continue to deduct stock-based compensation (SBC) from cash flow. The reasons for this I had already explained in detail.
After deducting net capital expenditures, this results in free cash flow of $5.82 billion for the first 9 months. Measured against an enterprise value of $266 billion, this is nothing to get excited about.
However, in my experience, investors in Pepsi stock focus on the company paying a reliable dividend and increasing it regularly. This is precisely the case when we look at the long-term development of dividends per share.
In the current year, Pepsi also plans to pay out a total of $6.2 billion in dividends and buy back shares worth $1.5 billion.
Deal with Celsius
At the beginning of August, there was another Message on which shareholders of the Celsius share had been speculating for some time. One of the 'big guys' got into the company and the name of the 'big guy' was Pepsi.
Pepsi had invested 550 million US dollars in Celsius and received an 8.5% stake in return. As of today, Celsius is valued at 14 times sales, but looking at the industry on the one hand, this is not unusual and could change very soon due to the cooperation with Pepsi.
According to Pepsi CFO Johnston, Celsius is already integrated into the network at 80%. Both CFO and CEO see Celsius as a useful addition to the energy drink portfolio alongside Rockstar and Mountain Dew. An assessment I share, by the way. Celsius is definitely aimed at a different group of buyers, which is more likely to be seen in the sports sector.
Conclusion
Pepsi delivers exactly what investors expect. A stock that provides security even in times of crisis and reliably pays out and increases dividends. Pepsi is not only able to successfully pass on the cost of inflation to its customers, but also to increase prices even more. Investors should nevertheless take the executives' statements seriously. In the long term, such jumps in sales are not possible.
Pepsi shares remain outside my portfolio due to their valuation.
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