Inflationary Challenges Fail to Cease Wide-Moat Pepsi’s Growth Momentum

We think wide-moat Pepsi’s (PEP) pricing power combined with the benefits of its scale and diverse portfolio were on display in the second quarter. The firm delivered 13% organic revenue growth, which strikes us as impressive when lapping 12.8% organic revenue growth in the same period a year ago. Further, although pricing was up 12.1%, aggregate volumes ticked up at a low-single-digit rate, evidencing the stout brand intangible assets Pepsi boasts. However, this strength was concentrated in the firm’s international arms, which clocked 7%-14% volume gains, in contrast to nearly no volume gains in its home turf. We attribute this languished unit growth in North American segments to the rash of cost pressures facing consumers at the pump and throughout the grocery store, trends we don’t perceive abating in the near term. However, we posit that Pepsi’s unwavering commitment to invest in research and development as well as marketing (which we model at around 6.5% and 1% of sales by 2026, respectively) should serve to buoy its competitive prowess over time.

Despite pronounced cost pressures, Pepsi’s stringent cost management manifested in 40 basis points of adjusted operating margin improvement (to 16.9%). We think that the firm can hold margins in the high-teens as it continues to enhance its cost profile through portfolio/channel optimization, price/pack architecture, and cost-saving initiatives, which we view as prudent.

Taken together, management edged up its fiscal 2022 top-line expectations (to 10% organic sales growth from 8% prior) but held in line on its 8% core constant currency EPS growth (implying core EPS of $6.63). We may adjust our near-term forecast based on results through the first six months of the year but see little to warrant a material change in our long-term forecast (which includes a mid-single-digit rate top-line growth). With shares trading near our existing $164 fair value estimate, we suggest investors await a more attractive entry point.