Will PepsiCo’s Focus On The Healthy Business Pay Off In The Third Quarter?
PepsiCo (NYSE:PEP) is set to report its third quarter earnings on October 4th, before the markets open. While the company has not provided a guidance for the quarter, analysts are expecting a revenue of $16.32 billion on earnings of $1.43 per share. The company is aiming for a 3% organic revenue growth this year. While in the first quarter, the company was only able to deliver a 2.1% growth, it rebounded in the second quarter to 3.1%. Keeping this in mind, it is imperative the company exceeds the 3% mark this quarter as well, otherwise reaching the target may turn out to be a stumbling block in the last quarter of this year. Adverse currency fluctuations continue to be a hindrance for PepsiCo, as it has a presence in over 200 countries. The company expects a two percentage point drag on the top and bottom-line from foreign currency translation during the year.
Importance Of The Healthy Products Segment
As it adapts to changing consumer preferences, PepsiCo believes that healthier products will be key for long-term growth and the company is looking at several ways to make its portfolio of products healthier. According to the company, its “everyday nutrition” products will witness the fastest rate of sales growth by 2025.
In order to meet the evolving needs of customers globally, the company is shifting its portfolio to a wider range termed as “Everyday Nutrition Products.” One of the main drivers of PepsiCo’s revenues in Q2 2017 was its portfolio of healthy snacks and beverages, and the company now derives approximately 45% of its revenues from these “Guilt Free Products” indicating that it has transformed its portfolio towards healthier products according to the new customer preferences. These products include “diet and other beverages that contain 70 calories or less from added sugar per 12-ounce serving and snacks with low levels of sodium and saturated fat” as well as “everyday nutrition products” – products with nutrients like grains, fruits and vegetables, protein, unsweetened tea, and water. These latter products constituted 28 points of the 45. LIFEWTR, a product in its water portfolio, performed particularly well in the second quarter. In just five months since its launch in the first quarter, the product had already generated sales of $70 million, and is on track to reach $200 million in sales on an annualized basis.
With the growth of its beverage business slowing down, as a result of sluggish soda sales, this segment will be a focus for the company in the future to drive its sales. Frito-Lay is also pushing towards a premiumization of its products to fuel its revenue and margin growth. Consumers have been moving away from eating unhealthy products, which has put pressure on the volumes. Hence, by concentrating on premium brands, there can be a shift from low-priced, high-volume products to the high-priced, low-volume range, which may result in top and bottom line growth.
Focus On The Gross Margins
A key factor to look into this quarter would be the gross margins for the company. Earlier this year, PepsiCo posted a third straight quarter of declining gross margins, owing to commodity inflation after a number of periods of commodity deflation. This trend, of rising commodity prices, is expected to continue, which could pressure the margins further. To combat this, the company intends to increase the prices. Hence, the margins may start to improve as the year goes on. The reported gross margin contracted by 55 basis points, while the core gross margin fell by 5 basis points in Q2. Meanwhile, the reported operating margin declined by 20 basis points, and its core operating margin expanded by 50 basis points, both of which were positively impacted by 60 basis points as a result of the Britvic sale. Looking forward, the company expects an expansion of its operating margin in the remainder of the year, fueled by its productivity programs.
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