The days are cooler, and the leaves are beginning to turn orange and red outside our windows here in the beautiful Old Town section of Alexandria, Va. While it's the beginning of autumn outside, it's the start of another type of season inside Fool HQ, as companies across the nation issue their quarterly earnings reports.
One of our Drip Port holdings, PepsiCo (NYSE: PEP), smiled as it delivered on a solid third quarter. Investors smiled back and drove the stock up 15%. Just for grins, I thought I'd take a quick look at the numbers to see if the company -- still trading near its two-year low -- is warranted in its optimism.
The details
Pepsi earned $0.56 a share for the quarter, which represents a 14% increase over the prior-year period. It's also the twelfth straight quarter of double-digit EPS growth. Compare that to the soft-drink industry's historical EPS growth rate of about 7%, and you can see how extremely solid and consistent that is -- obviously something we love to see in our Drip companies. In addition, CEO Steve Reinemund said that he's "confident that we will achieve the higher end of our 13% to 14% earnings-per-share growth target for this year."
Net sales for the company and all its subsidiaries came in at about $6.4 billion, 7% better than the third quarter last year and well above the industry's 1.27% historical average. Breaking it down, the Frito-Lay snack unit grew revenue by 3%, both the carbonated and non-carbonated beverage divisions in North America notched it up by about 8%, and international beverage sales were flat.
Quaker Foods revenue dropped off 4%, due mostly to "softness in ready-to-eat and hot cereals." That's understandable -- after all, who likes soggy cereal? (Insert laugh track here.)
About the only disappointment expressed in the various media reports was slower-than-expected growth from Frito-Lay. Apparently, analysts were expecting the unit to follow up better from a slow second quarter. However, the company says Frito-Lay's salty snack market share grew by almost 2%, its nineteenth straight quarter of maintaining or gaining share. That's a sweet statistic for a salty snack.
All the numbers are given on a "comparable basis," which excludes the costs associated with the Quaker Foods merger. It also treats 2001 results as if the goodwill accounting change and the consolidation of the European snack venture were already in place.
Cash flow
As good as the quarter was on the income statement, things look even better on the statement of cash flows. Pepsi generated $3.4 billion in cash from operations for the nine months ended Sept. 7, for a solid 39% increase.
To come up with the best measure of a company's profitability, free cash flow, all we have to do is back out capital expenditures. Labeled "Capital spending" in the earnings press release, capex totaled $807 million. Subtracting that number from $3.4 billion, we see that Pepsi generated about $2.6 billion in free cash flow for the 36-week period. That was 53% more than the same period in 2001.
Those are nine-month figures because that's what the press release shows us for the cash flow statement. If we want to see what happened during the third quarter only, we just subtract the numbers for the second-quarter earnings release (which has six-month totals) from the current third-quarter release.
Doing that, I came up with $1.5 billion in operating cash flow and $1.2 billion for free cash flow. Those figures are actually down from last year's third quarter by about 10%. This may be due more to a strong 2001 Q3 than any problems this quarter; we'll definitely put more store in the nine-month numbers.
Fun miscellany...
The company says it will reduce the number of Lay's potato chips in bags sold in the Northeast by a quarter of an ounce -- or about four or five chips. Reinemund says the move to 12-ounce bags is simply to standardize Lay's size with competing brands. According to Reuters, Pennsylvania-based Utz Quality Foods sells 12 ounces of potato chips for $2.99, the same amount Lay's currently charges for its 12.25-ounce bags.
The fourth-quarter promotional calendar calls for a Mountain Dew tie-in with The Simpsons. I can envision an episode in which Bart fills the gas tank of Groundskeeper Willie's tractor with the beverage, sending it into a caffeine-induced frenzy. The tractor then terrorizes children on the playground while Willie chases after it in his kilt.
Despite a two-thumbs down taste test from our own Rick Munarriz, the company says its launch of Pepsi Blue was successful. I tried my first taste of the "berry cola fusion" (don't ask me what that means) last weekend, and I pretty much agree with Rick. The first couple of sips weren't bad, but I wasn't able to finish the bottle. Luckily for Pepsi, Rick and I are a wee bit past the target market of teenagers and young adults. (But just a wee bit.) Otherwise, refrigerators across the nation would be sporting half-full bottles of the strange-looking fluid, casting an eerie blue glow over the tuna helper and unidentified mold experiments.
On that note...
All told (as opposed to half told), the third quarter appears to have been a good one. We have no reason to doubt Reinemund when he says, "Our overall business is in excellent health."
Even after this week's 15% rise, Pepsi's forward P/E is attractive, hovering around 20. The share price of $41.61 is still below our original cost basis. When it comes time to send in another Drip check, we'll definitely give this fizzy holding some consideration.
Having been called a "drip" all his life, Rex Moore feels right at home writing this column. He'd like to thank his mother for starting the tradition. You have the expressed written consent of the commissioner of baseball to view his holdings and the Fool's disclosure policy at any time.
