Pop 'n' chips powerhouse PepsiCo (NYSE:PEP) reports Q3 2007 earnings tomorrow morning. Want to know what Wall Street expects to see? Read on. Want to know what really matters? Read on a bit more.

What analysts say:

  • Buy, sell, or waffle? Fifteen analysts drink the Kool-Aid at Pepsi, rating it a buy rather than a hold, 14-to-1. The CAPS community agrees, rating it a full five out of five stars.
  • Revenues. They're looking for 11% sales growth to $9.9 billion.
  • Earnings. Profits are expected to grow a bit slower, up 9% to $0.96 per share.

What management says:
Analyst expectations seem at odds with what management's been leading us to expect, however. Last quarter, in a report that CEO Indra Nooyi modestly termed "excellent," Pepsi grew its sales a bit slower (10%), but translated that performance into 13% net income growth, and 15% improvement in earnings per share (thanks, buybacks).

After considering these results, Pepsi decided the time had come to raise guidance for the year. Thus, subject to what we hear tomorrow, at last report management was predicting it would earn "at least $3.35 per share" for the year, while generating about $7 billion in cash flow from operations.

What management does:
Doable? Heck, yeah. Pepsi's gross margins may be shrinking, but the firm's been pretty consistent in the operating margin department. At last report, it played second fiddle to Coca-Cola (NYSE:KO) in operating margins, and of course isn't getting the margins of wild-eyed newcomer Hansen Natural (NASDAQ:HANS). But Pepsi's margins still put those of Cadbury-Schweppes (NYSE:CSG), Kraft (NYSE:KFT), and Jones Soda (NASDAQ:JSDA) to shame. What's more, on the bottom line, Pepsi has grown its rolling net margin in every quarter over the past year-and-a-half.

Margins

3/06

6/06

9/06

12/06

3/07

6/07

Gross

56.4%

56.1%

55.5%

55.1%

55%

54.8%

Operating

18.1%

18.2%

18.2%

18.3%

18.5%

18.4%

Net

12.6%

12.7%

14.2%

16.1%

16.2%

16.3%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
So what's not to like about Pepsi? In a word: valuation. With the stock trading for nearly 20 times trailing earnings at last report, tomorrow's predicted profits growth of 9% would look positively anemic. Even the 15% per-share profits growth posted last quarter doesn't justify the stock price today -- and as for tomorrow, analysts by and large agree the firm will be hard-pressed to grow earnings much more than 11% per year long-term.

I might be inclined to overlook that if Pepsi were generating free cash flow in excess of net earnings, but it just isn't. To the contrary, over the last 12 months, Pepsi generated only $4.2 billion in free cash flow, versus nearly $6 billion in GAAP profits. As I read the guidance, management doesn't expect this to change by year-end, because accounting profits will continue to outstrip true, cash profitability. Until that situation reverses, or the stock price loses some of its fizz, I see little reason to join Generation Next.

Which is not to say Pepsi isn't doing some exciting things. Read about how Pepsi's gone back to the U.S.S.R. in:

Coca-Cola and Cadbury Schweppes are Inside Value picks. Kraft is an Income Investor recommendation. Try either service free for 30 days.

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.