The new Diet Pepsi "aspartame free" can. Source: www.pepsico.com
Beverage and snack behemoth PepsiCo (PEP 1.08%) reports third-quarter 2015 earnings Tuesday before the markets open. Let's take a brief look at five key themes investors may want to focus on to get a read on tomorrow's results.
1. The North America Beverages segment will try to hold the line
During last quarter's earnings conference call with analysts, CEO Indra Nooyi took some time in her opening comments to reflect on the company's eight-year quest to improve its innovation capabilities. Nooyi pointed out that much of PepsiCo's initial investment was focused on better research and development coordination among formerly decentralized business units.
PepsiCo is still very much engaged with improving the coordination of its resources. Last quarter, the company announced that it will remove Latin American beverages from its "Pepsi Americas Beverages" businesses to create a single Latin American snacks and beverages segment. In addition, PepsiCo has moved the "Sub-Saharan Africa" business from the "Asia, Middle East, and Africa" segment to the "Europe" segment.
The realignment will leave Pepsi Americas Beverages with only U.S. and Canadian beverage revenue, and the unit will be renamed "North America Beverages." Reporting for the reconfigured segments will begin this quarter.
For now, one of the most pressing questions is whether North America Beverages will continue to tread water as far as volume improvement is concerned. Using data issued by PepsiCo in August which restates historical operating results results within the new segment divisions, organic volume growth in this segment was flat last year, declined by 1% in Q1 2015, and was again flat last quarter.
2. Watch North American CSD volume
Speaking of North America, carbonated soft drink volume, or CSD, should be an area of great interest in the coming report. So far this year, growth in non-carbonated beverages has been offset by CSD weakness. In Q2 2015, a volume decline of 3% in CSDs undermined a 4% increase in non-carbonated beverages. Similarly for the year, non-carbonated beverages volume has widened 3%, versus a 2% decline in CSDs.
Any commentary on Diet Pepsi will also be highly anticipated. In mid-August, PepsiCo replaced the controversial sweetener aspartame with sucralose (known commercially as Splenda) in Diet Pepsi. Diet Pepsi sales declined more than 5% last year, and management has presented the ingredient swap as a reaction to customer demand. Shareholders should look for some detail on the initial reception of the ingredient change; this will likely occur during the company's earnings call with analysts.
3. Latin America: seeking cost improvements
The perceived opportunity to manage costs more efficiently in Latin America is a significant reason behind PepsiCo's recent segment reshuffling. Nooyi mentioned last quarter the company's previous success in consolidating food and beverage operations in Europe, as well as in its former Africa, Middle East, and Asia segment.
Despite headline-grabbing currency travails in high inflation environments like Argentina and Venezuela, Latin America is one of PepsiCo's most promising business segments. In 2014 Latin America ranked fourth in revenue among six segments, but carried the third highest profit margin, after Frito-Lay North America and Quaker Oats. Thus, the $1.6 billion in net profit contributed by the segment was also the third highest contribution to PepsiCo's bottom line, making up more than 14% of total company profit.
Investors can anticipate what are essentially promised margin improvements by management as early as this quarter, but especially over the next two to four quarters. By that time, efficiencies from combining the cost bases of the Latin American snacks and beverages revenue streams should begin to manifest themselves in the segment's results.
4. Will gross margin expansion continue?
PepsiCo has struggled to post positive revenue increases in recent quarters, as its global sales have been pressured by foreign currency translation. Last quarter, for example, despite an overall organic revenue increase of 5.1%, the company recorded a 6% revenue decline, due mostly to a 10% drag from foreign currency effects.
In the absence of dollar-denominated revenue growth, PepsiCo's management has emphasized the company's robust gross margin. Through the first two quarters of this year, PepsiCo's gross margin is running about 100 basis points higher than 2014, at 55.2%. A smidgen of pressure exists for management to have increased this margin in Q3 again. That's because, in the absence of revenue growth, gross margin leverage appears to be one of the supports under the company's current stock price.
5. A Frito-Lay deceleration?
Shareholders of PepsiCo have come to appreciate the U.S. snacks division for its predictable growth and cash flows. As Pepsi's second largest division, and the biggest contributor of profit dollars (supplying, at $1.9 billion, 38% of PepsiCo's net profit before corporate allocations so far this year), Frito-Lay North America, or FLNA, is a growth engine for the company and its investors.
Analysts are avidly awaiting the company's segment breakdowns in tomorrow's report, as it appears that Frito-Lay's revenue expansion might be tapering a bit. After increasing 2.6% in 2014, and rising more than 3% year over year in Q1 2015, FLNA managed a top-line increase of only 1.9% last quarter. Popping up above 3% again will reassure investors, whereas a further decline will certainly come under scrutiny.
