Global food and drink powerhouse PepsiCo (PEP -0.50%) reported third-quarter earnings to much fanfare. It deserved the kudos, given the strong growth it achieved and an increase in full-year 2022 guidance. However, if you dig into the quarterly results just a little bit, there are some weaknesses that you'll want to monitor closely.
A very positive showing
PepsiCo, which owns the iconic Pepsi and Frito-Lay brands, reported 8.8% year-over-year revenue growth in the third quarter. Organic revenue growth was a huge 16%. Adjusted earnings per share rose 14%. And that was achieved despite a 3 percentage point headwind from currency issues related to the strong dollar. Overall, the food maker had a good quarter.
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It gets even better because management upped its full-year 2022 guidance. Organic sales are now expected to rise 12%, a full 20% higher than its previous 10% target. Adjusted earnings per share are now projected to increase by 10% compared to the earlier guidance for an 8% improvement. Once again, there's a lot of good news going on.
A key part of the story, meanwhile, is the company's ability to increase prices in the face of inflation. It's what every consumer staples company is trying to do today, along with cutting costs, in an effort to protect operating margins. But this is a delicate dance that involves PepsiCo's direct customers (retailers) and its end customers (consumers). Once consumers start to push back, the process gets much harder.
Early warnings signs
That's why it's notable that PepsiCo's operations, which are split between food and beverages, are showing some signs of early trouble. On the beverage side, the company was able to increase volume by 3%. Only its European business saw a volume decline, but it wasn't enough to derail the entire division.
On the food side of PepsiCo's business, however, volume fell 1.5%. That's not massive, but four of the six regions/business lines it reports in the food space saw volume declines, including Frito-Lay North America and Quaker Foods North America. Those are important businesses. And, clearly, the two regions in which volume increased weren't enough to offset the negatives elsewhere.
Drinks and food are different. However, not so much so that you would expect one to be completely immune to the negative impact of price hikes while the other starts to see consumers trade down to lower-priced items. This is exactly how consumers voice their displeasure at rising product costs. It's far more likely that a decline on one side of PepsiCo's business should be seen as a warning that weakness could soon arrive on the other side.
That's not to suggest that PepsiCo's business is about to fall off a cliff. It has long been a reliable company that's used its strong brands to grow over time. Indeed, as a Dividend King, with five decades of annual dividend increases under its belt, it has clearly had to work through inflationary periods before. And it is highly likely to adeptly work though the current, albeit dramatic, inflationary period it faces today. But that doesn't mean the ride will be as smooth in future quarters as it was in the recent past.
Be prepared for a tougher 2023
If you are a long-term PepsiCo shareholder there's no reason to panic. It's still a well-run company worth owning. However, the difference between the company's food operations and its drinks shouldn't go unnoticed. The dichotomy suggests that PepsiCo could find the future increasingly challenging as the calendar flips over to 2023.
