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PepsiCo Talks Balancing Profitability and Growth

By Demitri Kalogeropoulos - Jul 12, 2019 at 1:45PM

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The snack and beverage giant still believes it can boost organic sales by 4% this year.

PepsiCo's (PEP 1.01%) growth momentum is holding up well. The beverage and snack-food giant just reported solid sales gains for the fiscal second quarter that nearly matched the high three-year expansion pace it posted three months ago.

Pepsi executives are predicting a tougher second half to the year, though, with revenue gains slowing and costs rising over the next two quarters. CEO Ramon Laguarta and his team broke down that forecast in a conference call with analysts, and below we'll take a closer look at what Pepsi had to say to investors this week.

A glass of soda.

Image source: Getty Images.

Snacks are working

[Frito-Lay] continued to post strong growth in the second quarter with organic revenue up 5% and solid market performance.
-- Laguarta

Pepsi's snack-food business, home to blockbuster brands like Doritos, Lay's, and Cheetos, continued its streak of robust growth. Organic revenue jumped 5% for the quarter and for the past six months, which translates into modest market-share gains. It wasn't all good news for the snack segment. Frito-Lay reported flat sales volumes, meaning all of its recent growth came from higher pricing.

Turning the corner on beverages

We're encouraged by the steady improvement we've seen in the [U.S. beverage] business and we believe that, as we execute our planned investment agenda, we'll see a return to sustained competitive performance.
-- Laguarta

The beverage division struggled again this period, with organic growth inching along at 2% as volumes declined. Management said those drops moderated when compared to the prior quarter, though, and so a return to growth might not be far away. And while many carbonated-beverage brands saw weak demand, Pepsi's ready-to-drink coffee and water franchises enjoyed robust volume gains.

Spending is rising

We've stepped up our brand investments, which is evident in the increase in [marketing] in the first half of 56 basis points as a percent of net revenue. We've [also] invested in advance data and analytics to enhance our consumer and shopper insights and sharpen the precision of our execution.
-- Laguarta

Higher spending in areas like advertising and manufacturing and distribution drove profitability lower. The drops were most pronounced in the Quaker Foods and beverage divisions, which played the biggest roles in pushing core earnings lower by 2.5% despite the 4.5% boost in organic sales. Consistent with the prior quarter, management couldn't point to specific ways in which this spending is producing tangible returns today. But they do believe the investments are helping revenue growth speed up to closer to 5% rather than the 2% or 3% rate investors have seen in recent years.

A difficult second half ahead

The organic revenue growth comparisons get meaningfully more challenging in the second half and ... our pace of planned reinvestments in the business will accelerate over the balance of the year, and you will see this reflected both in core EPS as well as in our operating margin performance.
-- CFO Hugh Johnston

Pepsi affirmed its full-year outlook that calls for sales to rise by 4% and for per-share earnings to decline by about 1%. Given the solid performance over the last six months, that prediction implies a significant worsening of operating trends in the fiscal third and fourth quarters. Management said the revenue slowdown mainly has to do with the high growth rates in the prior-year period, although Pepsi's weak sales volumes are also pressuring results.

As for earnings, they're expected to drop as the company spends even more aggressively on its investment initiatives. That strategy will put Pepsi on a firmer growth stance, but weaker profitability position, as it enters fiscal 2020.

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