Beverage and snack multinational PepsiCo (PEP +1.53%) reports on its second quarter of 2018 on July 10. The company's shares have lost roughly 9% year to date, potentially jeopardizing a nine-year streak of year-over-year stock price gains. Below are four items for investors to evaluate when PepsiCo issues its report, which provide context for the organization's current-year dip. These items may also prove pivotal as the PEP symbol attempts to recover ground in the back half of 2018.
Organic revenue range
In the first quarter of 2018, PepsiCo's top line increased 4.3%, but organic growth (reported revenue adjusted for acquisitions, divestitures, and foreign currency effects) expanded just 2%. Management's full-year outlook calls for revenue growth "at least in line with the 2017 growth rate of 2.3 percent." Thus, investors shouldn't expect a huge top-line result from the last three months -- a more moderate organic revenue advance of between 2% and 3% is reasonable. Flat or negative organic revenue growth, though, may put the current full-year expansion target out of reach, thus maintaining pressure on PepsiCo shares.
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North America Beverage travails
One of the constraints to organic revenue improvement lies within the company's largest segment, North America Beverages, or NAB. Last quarter, NAB reported a volume decrease of 3% and an organic revenue decline of 2%, continuing a trend of under-performing quarters. On PepsiCo's first-quarter earnings conference call, CEO Indra Nooyi reviewed the company's portfolio expansion efforts beyond its trademark sugary beverages, while highlighting the organization's innovation within low-sugar soda variants. Nooyi then keyed in on the primary reason NAB's formerly steady expansion has stalled:
The overwhelming driver is that, despite moderately increasing our media on trademark Pepsi over the past three years, our share of voice has fallen dramatically relative to our key competitor, who has substantially stepped up their media spending on colas over the past two years.
Indeed, rival Coca-Cola (KO +0.84%) has increased its marketing spends on flagship soda beverages even as it's mirrored PepsiCo's strategy of diversifying into healthier, non-sparkling beverages. In the first quarter of the year, Coca-Cola re-launched Diet Coke as a millennial-friendly beverage sporting five flavor variants, enclosed in sleekly designed, 12-oz cans. During Coca-Cola's first-quarter earnings conference call, CEO James Quincey observed that the initial relaunch volumes of Diet Coke have been positive, though the company hasn't shared any hard metrics yet. Market share gains won by a reinvigorated Diet Coke will almost certainly come at the expense of Diet Pepsi, which has required inordinate investment on PepsiCo's part to maintain its quarterly volumes.
The actions of both companies demonstrate that despite a horde of new beverage innovation in water, sports drinks, tea, ready-to-drink coffees, and even dairy categories, it's crucial for PepsiCo and Coca-Cola to stabilize and even marginally grow global volume in sodas. Shareholders should check in on NAB's organic growth this quarter and look for further commentary from management on the company's strategy to invest in its trademark billion-dollar cola brands.
A profitability obstacle
PepsiCo's gross margin may reveal compression this quarter, as profitability headwinds have emerged in the consumer packaged goods (CPG) industry. These include higher freight costs due to tight capacity in the trucking market, raw materials price inflation, and higher aluminum input costs resulting from the Trump administration's tariffs on imported steel and aluminum. In the first three months of the year, PepsiCo's gross margin declined 110 basis points to 54.9%. The company blamed commodity price inflation, a factor that is likely to have persisted into the second quarter.
Pressure on gross margin can be exacerbated when a company's top line remains in a flattish trend, as PepsiCo's has been. Last year, PepsiCo's reported revenue expanded by just 1.1%, although in the first quarter of 2018, revenue rose 4.3%. A flat or slightly negative revenue result in the second quarter may heighten margin compression, and such a scenario will bring profitability worries to the fore during the remainder of 2018. Over the last year, PepsiCo has been able to mitigate margin pressure through productivity increases, and shareholders will look for this offsetting effect to continue in the second quarter.
Recent -- and future? -- acquisitions
On May 25, 2018, PepsiCo announced an agreement to acquire Bare Foods Co, parent company of crunchy baked vegetable and fruit chip maker Bare Snacks. Bare Foods will operate independently within PepsiCo's Frito Lay North America segment (FLNA). The purchase is noteworthy because Bare Snacks' products merge two trends that FLNA has excelled in exploiting over the past few years: savory/salty snacks and "better-for-you" packaged foods.
As I discussed this spring, FLNA dominates the market for salty snacks in the U.S. through power brands like Lays potato chips, while its specialized, direct store delivery (DSD) distribution model gives it the ability to ramp up volume in newer brands, especially in the better-for-you category. As NAB has faltered, FLNA has picked up the slack. At $3.6 billion in revenue last quarter, FLNA is PepsiCo's second-largest division. Over the last several quarters, FLNA has supplied the sales to keep the company's overall top line stabilized and growing at the 2%-plus organic rate level. Last quarter, FLNA expanded volume by 2%, and organic revenue by 3%.
Financial terms of the Bare Foods transaction haven't been disclosed. Look for commentary from PepsiCo on its plans to scale Bare Snacks' business through FLNA's distribution system, as well as any intention on management's part to engage in additional bolt-on acquisitions of upstart, better-for-you brands this year. Further investment in this fast-growing category could provide a tangible catalyst for PepsiCo shares in the coming quarters.
