Earnings reports. The concept seems almost quaint in an investing world gone mad. Yet earnings season is once again upon us, and pop 'n' chips powerhouse PepsiCo (NYSE:PEP) reports its Q3 2008 numbers tomorrow. Here's what you need to know to make sense of them.

What analysts say:

  • Buy, sell, or waffle? Fourteen analysts still drink the Kool-Aid at Pepsi, giving it 10 buy ratings versus just four holds.
  • Revenues. They're looking for 10% sales growth to $11.2 billion.
  • Earnings. Profits are expected to lag a little, up 9% to $1.08 per share.

What management says:
When last we heard from Pepsi, the story was similar to what analysts are looking for tomorrow. Second-quarter sales were up 14% last quarter, while profits trailed in at 11% growth in earnings per share. Pepsi's doing its darnedest to boost that latter number, though, promising to buy back at least $5.3 billion worth of its own stock this year.

If management follows through on its vow, that should concentrate firmwide profits among fewer shares outstanding and help Pepsi achieve its latest guidance number: $3.72 per share for the year.

What management does:
Pepsi's problems point directly to a compression in profit margins. And as you'll see in the table below, this has been brewing for quite a while. Regardless, Pepsi continues to lag only two major companies in its snacks 'n' soda space -- archrival Coca-Cola (NYSE:KO) and upstart Hansen Natural (NASDAQ:HANS). In contrast, Pepsi still leads Dr Pepper Snapple (NYSE:DPS), Kraft (NYSE:KFT), and Jones Soda (NASDAQ:JSDA) by comfortable, er, margins.

Margins

3/07

6/07

9/07

12/07

3/08

6/08

Gross

55.0%

54.8%

54.7%

54.3%

54.1%

53.8%

Operating

18.8%

18.8%

18.5%

18.4%

18.3%

18.3%

Net

16.2%

16.3%

16.5%

14.3%

14.1%

14.0%

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:
From whence hail these contractions in profit margin? From thence -- at the top of the income statement.

Focusing on the first half of this fiscal year, we see Pepsi's sales up 14% through the end of H1 -- not too shabby in a recessionary environment. However, commodities costs are still squeezing Pepsi's profits, with cost of goods sold up nearly 17% year to date (in comparison to H1 2007). Meanwhile, Pepsi's doing a fine job of controlling those costs it can control, holding selling, general, and administrative spending to just an 11% rise.

And here's the good news: By virtue of depressing demand, recessions tend to deflate commodities costs. If this one works the way others have in the past, we could see Pepsi's raw materials costs begin to mitigate soon, relieving the margin pressure and allowing profits to pop.

Fingers crossed.

Like your first bottle of Pepsi commentary? Down another one (or three) with:

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy. Coca-Cola is an Inside Value selection. Kraft has been recommended by Income Investor.