Beverage Portfolio Surprises in Pepsi's Q3 Earnings

With wide-moat PepsiCo’s PEP stock rallying in the days leading up to its third-quarter earnings print, it seemed like investors were becoming increasingly enamored by the prospects of: 1) continued growth in snacks, 2) recovery in beverages, and 3) moderating coronavirus-related costs. The firm delivered on almost all fronts, culminating in top- and bottom-line beats relative to CapIQ consensus. Management’s full-year guidance (4% organic growth and core EPS of $5.50) was a smidge ahead of our expectations though not meaningful enough to alter our $140 fair value estimate, leaving the shares fully valued in our view.

Revenue came in at $18.1 billion, reflecting year-over-year growth of 5.3%. With the coronavirus increasing the frequency of various snacking occasions, the robust 6% organic growth in the snack and food portfolio came as no surprise, but the 3% increase in beverages was stronger than we anticipated, due to the confluence of strength in the off-trade and less precipitous declines in food service. We were particularly pleased with the North America beverage business (up 3% organically), and with commentary regarding improvement in the U.S. convenience channel. Better leveraging scale and portfolio scope to win more placements in this channel was a key rationale of the firm’s recent moves in the energy category, namely the Rockstar acquisition and the Bang distribution agreement. As mobility improves, we expect stakeholders within this channel to become less focused on survival and more focused on growth, which should allow Pepsi more latitude to execute against its initiatives.

Core operating margin was resilient, down only 40 basis points to 16.8%. Margins this year have largely been a function of direct COVID-19 costs as well as other corollaries of the crisis and their impacts on strategic investments (like advertising). Profitability will likely be volatile in the near term, but we still see plenty of room for margin expansion longer term.

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