PepsiCo's Profit Pops (News) October 7, 1999

PepsiCo's Profit Pops

By Richard McCaffery (TMF Gibson)
October 7, 1999

Number two soft drink maker PepsiCo (NYSE: PEP) posted better-than-expected pro forma earnings of $0.34 per share for the quarter ended September 4, eclipsing First Call mean estimates by a penny. It was a nice surprise from the Purchase, New York company, which last month warned investors of lower operating income based on slower Pepsi sales in North America.

Strong sales in the company's Frito Lay and Tropicana divisions as well as from its bottling partners took up the slack. Pro forma net income (which includes the purchase of Tropicana, spinning off a large chunk of the Pepsi Bottling Group (NYSE: PBG), and other transactions) jumped 7% to $507 million. In fact, net income grew faster than pro forma revenues, which increased 6% to $4.6 billion, a sign the company is paying close attention to operations.

Still, the competitive environment in North America weakened the company's operating profit. Industrywide price increases slowed sales, and, to compensate, Pepsi boosted marketing expenses. These expenses and lower shipments of Pepsi-Cola led to a 17% drop in pro forma operating profit for the cola division. Overall, PepsiCo's pro forma operating profit for the quarter declined to 16.1% from 16.7% a year ago. (Looking at the year as a whole, the decline is not nearly as steep.)

It's been a rocky year for soft drink makers. The strong dollar hurt international sales, and higher prices domestically took a bite out of sales growth. But PepsiCo has seen major benefits from its three-year transformation to focus its strategy and improve returns.

In 1997 it spun off Pizza Hut, Taco Bell, and KFC as Tricon Global (NYSE: YUM). In 1998 it purchased Tropicana, the world's leading juice company. In 1999 it spun off its low-margin bottling operations. The company has taken the extra cash and poured it into operational improvements in areas like information technology. The company has spent millions on a new IT system that will trim costs from supply chain management and sharpen its category management starting next year.

Though operational cash flow is down 4.2% for the first nine months of 1999 compared to last year, the company continues to generate more cash from operations than it reports as net income -- a nice sign of true profitability. In fact, since the company used just $582 million in investing activities so far this year, it's had $1.3 billion in free cash flow to pour into cool moves like its $3 billion share repurchase program.

PepsiCo's biggest problem is the four-letter word it has to compete with: Coke (NYSE: KO). It's hard being number two when the top dog is among the world's greatest companies, but investors have to love PepsiCo's commitment to shareholders.

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