PepsiCo Earnings: Innovation and Productivity Gains Fuel Profit Growth; Shares No Bargain

We plan to raise our fair value estimate for wide-moat PepsiCo PEP by a low-single-digit percentage after digesting better-than-expected second-quarter results driven by snack and beverage innovations, brand investments, and productivity gains. Organic revenue grew 13% and core EPS was up 15%, both edging our estimates (12% and 13%, respectively). The firm revised up 2023 organic revenue and EPS growth guidance to 10% (from 8%) and 12% (from 9%), respectively, which we view as attainable, and we plan to tick up our own 2023 forecast to approximate the updated outlook. Our 10-year projections for mid-single-digit sales growth and high-single-digit EPS expansion remain in place. We see shares trading at a slight premium to our fair value estimate after the planned increase, and suggest investors wait for a better entry point.

We attribute the strong sales growth to brand investments, innovation and commercial initiatives that reinforce PepsiCo’s differentiated value proposition even as consumers turn more cautious about their grocery spending amid macro uncertainties. Despite a 15% price increase (in line with commodity cost inflation), volume was resilient (down 2.5%), with the snack business a bright spot, delivering volume expansion (up 0.5%). We view snack innovation in flavors, portion size, and packaging for on-the-go consumption as adding variety, convenience, and consumption occasions, which should bode well for growth in years to come. Meanwhile, popular zero-sugar sodas, new sports drinks, and progress in malt beverages (with licenses obtained to distribute Hard Mountain Dew in the U.S.) should help maintain the firm’s competitive edge in the beverage aisle. We are impressed by productivity gains from automation, data-driven route optimization, and standardized commercial operations, which allowed the firm to raise advertising spending by double digits in the quarter (true to its commitment to branding) while eking out a 44-basis-point operating margin gain.