Profitability Continues to Improve at Pepsi

We don’t plan major changes to our $103 fair value estimate for wide-moat

PEP after third-quarter results. The firm continues to expand margins, while foreign exchange rates weigh on reported revenue. North American Beverages, against tough comps, exhibited strong volume growth, as did the emerging markets. Pricing generally remains solid, providing evidence of the firm’s strong brand intangible asset. Pepsi is on track to meet our full-year forecast.

We’ve expected the firm’s productivity initiative to drive steady margin improvement, and Pepsi is delivering, with $1 billion in productivity savings this year. Third-quarter operating margin grew 30 basis points over last year, and the company is tracking our 16.3% forecast for 2016, a 50-basis-point improvement over 2015. Productivity--via automation, the use of technology in SG&A, and smarter spending--was a primary driver of the margin expansion, and we expect it, along with continued pricing strength, to drive margin improvement for the next few years.

North American Beverages led, improving operating margin by 110 basis points. Against a strong 2015 comparison, the segment grew third-quarter revenue by 3%, driven by 2% volume and 1% pricing growth. It is in line to meet our 4% 2016 revenue growth forecast. We believe carbonated soft drinks face long-term challenges, but pricing has been strong, and Pepsi is better insulated than competitors.

Frito-Lay was the other segment driving margin improvement, with a 40-basis-point gain. It continues to grow both volume and pricing, 2% and 1%, respectively, this quarter and is tracking our 3% revenue growth forecast for the year. Conversely, Quaker saw quarterly revenue decline 2%, driven entirely by lower volume. Snacks were strong in every region internationally, highlighted by the AMENA segment’s 10% volume growth. We expect foreign exchange headwinds will limit revenue growth to 3% in AMENA this year, but we see that rising to the 8% range in 2017 and beyond.

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