Analysis: PEP KO KDP

Earlier this morning we touched on "Two"-rated PepsiCo (PEP)  delivering better-than-expected June-quarter results and lifting its 2022 organic revenue outlook to 10% vs. its prior guidance of 8%. But given the dollar's strength and foreign exchange headwinds, we'd note that PepsiCo's organic revenue excludes those factors, which will be hot topics in the weeks ahead. PEP's earnings per share for the quarter came in at $1.86, well ahead of the $1.74 consensus forecast and up from $1.72 in the year-ago quarter. Lending a helping hand to those EPS comparisons, PepsiCo repurchased 3.1 million shares at an average prices of $168.66 during the quarter.

The company's Q2 revenue gains, up 5.2% year-over-year on a reported basis and 13.0% on an organic revenue basis, were largely driven by the Frito-Lay North America, Quaker Foods North America, and Latin America segments. Those increases more than offset modest year-over-year revenue declines at the company's PepsiCo Beverages North America and Europe business. Aggregating the company's businesses into global convenient foods and global beverage, those buckets delivered organic revenue growth of 17% and 8%, respectively, reaffirm our decision to add PepsiCo shares to the portfolio, because of the snacking business vs. beverage-only Coca-Cola (KO)  or Keurig Dr. Pepper  (KDP) . From a geographic perspective, total North American delivered 11% organic growth while International rose 15%.

Looking at the quarter's results from an operating profit perspective, year-over-year gains matched the segment revenue changes as well, which resulted in aggregated operating profit rising 7.5% year-over-year, a quicker pace than reported revenue. Once again the largest driver of operating profit was Frito-Lay North America, which accounted for just under 40% of total operating profit generated in the quarter.

On the earnings conference call, management reiterated its plan to return PepsiCo Beverages North America to mid-teens margins vs. low double digits posted in the June quarter. As it executes on those plans, the company will continue to expand its line of "Zero Sugar" offerings and move further expand its line up of zero-calorie "mocktails." We see that moving PepsiCo in lock step with the evolving taste and health consumer preferences.

Some of the key observations from the company's earnings report and conference call are that it is enjoying a higher-than-historical level of elasticities for its products, even after having boosted price increases in recent quarters. That stickiness paired with modest volume growth is powering the company's upped revenue guidance. Second, cost cutting efforts will continue as the PepsiCo looks for other ways to offset inflation. But it was the comment from CFO Hugh Johnston to Reuters that really caught out attention as given the levels of elasticity it is seeing, there is room for prices to go up further.

Given the almost duopoly found in the beverage business between PepsiCo and Coca-Cola, we wouldn't be surprised by another round of price increases. It would also lend a helping hand to improving margins, a key target for PepsiCo Beverages North America. As we've shared with members, the "beauty" of these price increases is that when inflation subsides and potentially key input costs decline, these price increases become margin and EPS levers. After all, how often have we seen a consumer-packaged goods company cut prices? 

Given the EPS beat tied to the June quarter, we'll bump our price target to $180, which keeps our "Two" rating intact. Should PepsiCo announce an additional round of pricing action, we'll look to revisit our price target. But, to revisit our "Two" rating, we would need to see upside in the shares to at least $195. In the meantime, we see modest downside in the shares given the likely support to be had from PepsiCo's buyback pledge to repurchase $1.5 billion in stock during 2022. Exiting the June quarter, it has $0.8 billion left to go and a much larger slug of $9.7 billion left under the repurchase authorization that doesn't expire until early 2026.

In the near-term, our plan with PEP shares will be to scoop them up on pullbacks.