Juiced Results at Pepsico

Pepsico (NYSE:PEP) reported third-quarter earnings last Thursday, and although sales and earnings growth were strong, the market is becoming concerned about rising commodity and manufacturing costs in North America. Does the recent share weakness mean a buying opportunity?

Pepsi's stock is down a couple of percentage points since the earnings release over concerns that rising input costs could dent profitability at some point in the near future. While increased orange costs have so far been passed on to consumers in the form of higher Tropicana orange juice prices, analysts suggest that further price hikes will begin to dent sales. Additionally, higher Gatorade production expenses hit operating profit in the North America beverage unit.

In any case, total sales grew 9.4% for the quarter. Pepsico International (PI), which comprises the international beverage (soda and orange juice) segment and certain Quaker snacks, saw the biggest sales increase -- 16.2% for the quarter. That was followed by a 10.4% increase at Quaker Foods North America (QFNA), which sells cereal, rice, pasta, and other foods. Sales of Frito Lay North America (FLNA) snack foods grew 7.4%, while the Pepsico Beverages North America (PBNA) segment was the laggard, with 3.5% sales growth. To give you a feel for how important each group is in the overall sales mix, PI represented 35% of total 2005 sales, QFNA 5%, FLNA 33%, and PBNA 28%. Results for the quarter were in line with those percentages and demonstrate that Pepsico is diversified from a product and geographic standpoint.

Net profit advanced 71.4% at first glance, but stripping out a tax charge in the third quarter of last year leaves the gain at 12%, which is just above the average annual earnings growth rate of 11.5% that Pepsi has reported over the last three fiscal years.

Management expects full-year earnings of "at least" $2.98 for 2006 and operating cash flow of $6.2 billion, with capital expenditure of $2.2 billion. Based on the current diluted share count, that's approximately $2.37 in per-share free cash flow for a rather lofty price-to-free-cash-flow multiple of 26.4.

Regardless of any near-term concerns, Pepsi continues to post impressive top- and bottom-line growth. Years of double-digit expansion recently allowed Pepsi to overtake rival Coca-Cola (NYSE:KO) in terms of market capitalization. Both stacked up well when I last compared them in a Foolish Face-Off, but I gave the edge to Pepsi, due to its better-diversified snack food and beverage portfolio and more robust growth prospects as Coke tries to find ways to kick-start its own growth. Frito Lay looks to be uniquely positioned as a dominant salty snack food provider, but most Quaker products compete in the ultra-competitive food industry with the likes of Kellogg (NYSE:K), Kraft (NYSE:KFT), General Mills (NYSE:GIS), and even international behemoth Unilever (NYSE:UN).

Overall, in my opinion, Pepsi's valuation is a bit too high, as it will have to post many more years of double-digit growth to justify the current stock price. The recent haircut after third-quarter earnings has helped, but the stock could be had for less than $60 just earlier this year. Until a better entry point shows itself, Pepsi will remain on my all-star watch list.

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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.