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ANALYSIS

PepsiCo reports results for Q3 of 2018; Updates 2018 financial targets
Thursday, 04 October, 2018, 08 : 00 AM [IST]
Purchase
PepsiCo Inc reported results for the third quarter of 2018. “We are pleased with our results for the third quarter,” said Indra Nooyi, the company’s chairman and chief executive officer.

“We continued to see a very strong operating performance from our international divisions, propelled by developing and emerging markets; Frito-Lay North America generated solid net revenue and operating profit growth; and North America Beverages delivered another quarter of sequential improvement in top-line performance,” he added.

“On the strength of our year-to-date results, we have revised upward our full-year organic revenue growth target. Additionally, given the recent strengthening in the dollar, we have revised our full-year core earnings per share target to reflect our updated expectation of an approximate one percentage point headwind from foreign exchange translation,” he added.

Reported generally-accepted accounting principles (GAAP) third-quarter and year-to-date 2018 results


Third quarter

Year-to-date

Net revenue growth

1.5%

2.6%

Foreign exchange impact on net revenue

(2)%

%

Earnings per share (EPS)

$1.75

$3.97

EPS growth

18%

3%

Foreign exchange impact on EPS

(2)%

%


Organic/core (non-GAAP) third-quarter and year-to-date 2018 results


Third Quarter

Year-to-Date

Organic revenue growth

4.9%

3.4%

Core EPS

$1.59

$4.17

Core constant currency EPS growth

9%

6%


Summary of third-quarter financial performance
• Reported third-quarter and year-ago results were impacted by a provisional transition tax expense related to the Tax Cuts and Jobs Act (TCJ Act), a non-cash tax benefit resulting from the conclusion of certain international tax audits, restructuring charges and commodity mark-to-market net impacts
• Reported net revenue increased 1.5 per cent. Foreign exchange translation had a two-percentage-point unfavourable impact on reported net revenue growth. Organic revenue, which excludes the impacts of foreign exchange translation and acquisitions, structural and other changes, grew 4.9 per cent
• Reported gross margin contracted 30 basis points and core gross margin contracted 10 basis points. Reported operating margin contracted 75 basis points and core operating margin contracted 25 basis points
• Reported operating profit decreased three per cent and core constant currency operating profit increased two per cent. Commodity mark-to-market net impacts and restructuring charges negatively impacted reported operating profit performance by two percentage points and 1 percentage point, respectively. Foreign exchange translation negatively impacted reported operating profit performance by two percentage points
• The reported and core effective tax rates in the third quarter of 2018 were seven per cent and 17.6 per cent, respectively. The reported and core effective tax rates in the third quarter of 2017 were 22.3 and 22.2 per cent, respectively. A non-cash tax benefit resulting from the conclusion of certain international tax audits reduced the reported effective tax rate by 13 percentage points. The provisional transition tax expense increased the reported effective tax rate by three percentage points
• Reported EPS was $1.75, an increase of 18 percent from the third quarter of 2017. Foreign exchange translation negatively impacted reported EPS growth by two percentage points
• Core EPS was $1.59, an increase of seven per cent. Excluding the impact of foreign exchange translation, core constant currency EPS increased nine per cent
• Net cash provided by operating activities was $3.6 billion

Discussion of third-quarter 2018 reported division results

Frito-Lay North America (FLNA)
Operating profit increased 3.5 per cent, primarily reflecting the net revenue growth and planned cost reductions across a number of expense categories, partially offset by certain operating cost increases.

Quaker Foods North America (QFNA)
Operating profit decreased 1.5 per cent, reflecting certain operating cost increases and unfavourable net pricing and mix, as well as higher commodity costs which negatively impacted operating profit performance by 2.5 percentage points. These impacts were partially offset by planned cost reductions across a number of expense categories, lower advertising and marketing expenses and the volume growth. Additionally, insurance settlement recoveries related to the 2017 earthquake in Mexico positively contributed two percentage points to the operating profit performance.

North America Beverages (NAB)
Operating profit decreased 14 per cent, reflecting certain operating cost increases, including increased transportation costs, higher commodity costs which negatively impacted operating profit performance by nine percentage points and higher advertising and marketing expenses. These impacts were partially offset by the net revenue growth and planned cost reductions across a number of expense categories.

A current-year gain associated with a sale of an asset positively contributed four percentage points to operating profit performance and was offset by a gain associated with a sale of an asset in the prior year, which negatively impacted operating profit performance by three percentage points.

Latin America
Operating profit increased slightly, reflecting planned cost reductions across a number of expense categories, the effective net pricing and the volume growth, as well as insurance settlement recoveries related to the 2017 earthquake in Mexico which contributed five percentage points to operating profit growth.

These impacts were offset by certain operating cost increases and higher advertising and marketing expenses, as well as higher commodity costs which reduced operating profit growth by 15 percentage points. Unfavourable foreign exchange translation reduced operating profit growth by six percentage points.

Europe Sub-Saharan Africa (ESSA)
Operating profit increased three per cent, reflecting the net revenue growth and planned cost reductions across a number of expense categories. These impacts were partially offset by certain operating cost increases and higher advertising and marketing expenses, as well as higher commodity costs which reduced operating profit growth by seven percentage points. Unfavourable foreign exchange translation reduced operating profit growth by five percentage points.

Asia, the Middle-East and North Africa (AMENA)
Operating profit increased 17 per cent, reflecting the effective net pricing, planned cost reductions across a number of expense categories and the volume growth. These impacts were partially offset by certain operating cost increases and higher advertising and marketing expenses.

Additionally, higher commodity costs reduced operating profit growth by six percentage points and the impact of refranchising our beverage businesses in Thailand in 2018 and Jordan in 2017 reduced operating profit growth by four percentage points.

Summary of year-to-date financial performance
• Reported year-to-date 2018 and 2017 results were impacted by a provisional transition tax expense related to the TCJ Act and non-cash tax benefits resulting from the conclusion of certain international tax audits and our resolution with the Internal Revenue Service (IRS) of all open matters related to the audits of taxable years 2012 and 2013 (the 2012 and 2013 audit resolution), restructuring charges and commodity mark-to-market net impacts
• Reported net revenue increased 2.6 per cent. Foreign exchange translation did not have a significant impact on reported net revenue growth. Organic revenue, which excludes the impacts of foreign exchange translation and acquisitions, structural and other changes, grew 3.4 per cent
• Reported gross margin contracted 50 basis points and core gross margin contracted 35 basis points. Reported operating margin contracted 50 basis points and core operating margin contracted 40 basis points
• Both reported and core constant currency operating profit did not change significantly compared to the prior year. Commodity mark-to-market net impacts negatively impacted reported operating profit performance by one percentage point while restructuring charges had a nominal impact. Foreign exchange translation did not have a significant impact on reported operating profit performance
• The reported and core effective tax rates year-to-date 2018 were 21.5 per cent and 19.1 per cent, respectively. The reported and core effective tax rates year-to-date 2017 were 22.9 and 22.8 per cent, respectively. The favourable conclusion of certain international tax audits and the 2012 and 2013 audit resolution, collectively, reduced the reported effective tax rate by nine percentage points. The provisional transition tax expense related to the TCJ Act increased the reported effective tax rate by 12 percentage points
• Reported EPS was $3.97, an increase of three per cent. Foreign exchange translation did not have a significant effect on reported EPS growth
• Core EPS was $4.17, an increase of six per cent. Foreign exchange translation did not have a significant impact on core EPS growth
• Net cash provided by operating activities was $4.7 billion

Discussion of year-to-date reported division results
Frito-Lay North America (FLNA)

Operating profit increased three per cent, primarily reflecting the net revenue growth and planned cost reductions across a number of expense categories. These impacts were partially offset by certain operating cost increases, as well as higher commodity costs, primarily potatoes and motor fuel, which reduced operating profit growth by two percentage points. Additionally, a bonus extended to certain US employees in connection with the TCJ Act reduced operating profit growth by one percentage point.

Quaker Foods North America (QFNA)
Operating profit decreased two per cent, reflecting the net revenue performance and certain operating cost increases, as well as higher commodity costs which negatively impacted operating profit performance by three percentage points. These impacts were partially offset by planned cost reductions across a number of expense categories and lower advertising and marketing expenses. Additionally, insurance settlement recoveries related to the 2017 earthquake in Mexico positively contributed one percentage point to operating profit performance.

North America Beverages (NAB)
Operating profit decreased 17 per cent, reflecting certain operating cost increases, including increased transportation costs, as well as higher commodity costs which negatively impacted operating profit performance by seven percentage points. These impacts were partially offset by planned cost reductions across a number of expense categories. Current-year gains associated with sales of assets positively contributed three percentage points to operating profit performance and were offset by a gain associated with the sale of an asset in the prior year, which negatively impacted operating profit performance by one percentage point. A bonus extended to certain US employees in connection with the TCJ Act negatively impacted operating profit performance by two percentage points.

Latin America
Operating profit increased 15 per cent, reflecting the net revenue growth and planned cost reductions across a number of expense categories, as well as insurance settlement recoveries related to the 2017 earthquake in Mexico which contributed five percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and higher advertising and marketing expenses, as well as higher commodity costs which reduced operating profit growth by 11 percentage points. Lower restructuring and impairment charges contributed six percentage points to operating profit growth.

Europe Sub-Saharan Africa (ESSA)
Operating profit decreased two per cent, reflecting certain operating cost increases and higher advertising and marketing expenses. Additionally, a prior-year gain associated with the sale of our minority stake in Britvic and higher commodity costs negatively impacted operating profit performance by nine percentage points and five percentage points, respectively. These impacts were partially offset by the net revenue growth and planned cost reductions across a number of expense categories.

Asia, Middle East and North Africa (AMENA)
Operating profit increased 34 per cent, primarily reflecting the net revenue growth and planned cost reductions across a number of expense categories, as well as the net impact of refranchising our beverage businesses in Thailand in 2018 and Jordan in 2017, which contributed 15 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, as well as higher commodity costs which reduced operating profit growth by four percentage points.

2018 guidance and outlook
The company provides guidance on a non-GAAP basis, as it cannot predict certain elements which are included in reported GAAP results, including the impact of foreign exchange translation and commodity mark-to-market impacts.
 
The company updated its 2018 financial guidance and now expects:
• Full-year organic revenue growth to be at least three per cent
• Based on current market consensus rates, foreign exchange translation to have a one percentage point negative impact on reported net revenue and earnings per share growth
• A core effective tax rate between 19 and 20 per cent, reflecting benefits of the TCJ Act
• Core earnings per share of $5.65, an eight per cent increase compared to 2017 core earnings per share of $5.23 reflecting the expected unfavourable one percentage point foreign exchange translation impact
• Approximately $9 billion in cash from operating activities and free cash flow of approximately $6 billion, which now assumes net capital spending of approximately $3.3 billion and a discretionary pension contribution of $1.4 billion

The company continues to expect:
• Core constant currency EPS growth of nine per cent
• The benefit of the TCJ Act to be substantially reinvested in initiatives to benefit the company’s US-based front line workforce and to otherwise increase the company’s capabilities
• Total cash returns to shareholders of approximately $7 billion, total dividends to shareholders of approximately $5 billion and share repurchases of approximately $2 billion
 
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