On Wednesday, Pepsico (PEP) once again smashed earnings estimates. It also hiked its earnings outlook for the second straight time this year, as it continues to benefit from a combination of input cost deflation, a shift to lower calorie drinks and the global trend toward snacking.
The quarter is part of the Action Alerts PLUS holding's magic carpet ride, which it has enjoyed for the past year -- with steady performance in an unsteady packaged food space. Shares have tacked on a cool 17%, outperforming the S&P 500's 12% gain. The ride for investors is unlikely to end looking out toward 2017, unless the stock market reaches bubble fever and sends investors barreling into faster-growth names, or food inflation runs rampant. Ongoing cost cuts and share repurchases will continue for Pepsi, which will only enhance the stories behind two foundational elements to the company.
Snack Portfolio Is Ridiculously Good
Pepsi is dominating the snack industry during a period in which consumers continue to shift toward snacking over meals. How much better positioned can one be? The company is driving mid-single-digit percentage sales growth at Frito-Lay, has strong operating margins above 30%, and continues to stock the innovation pipeline.
Consider the following fun fact. Over the past few years, according to Credit Suisse, Frito-Lay's operating margins have gradually improved 40 to 100 basis points per year. They breached the 30% threshold in the second quarter of this year -- reaching 30.5%. Credit Suisse estimates Frito-Lay is on track to earn about $4.6 billion in profits this year. Not only is Pepsi proving that it has a sustainable business, but it's showing it could expand the business via targeted marketing and new innovations.
In the third quarter, core operating profits for Frito-Lay North America rose a solid 5%, outpacing a 3.5% increase in organic revenue.
Eventually, it's very plausible Pepsi takes profits from a Frito-Lay and gobbles up an Amplify Snack Brands (BETR) . Amplify is doing some great things in snacks, and it would be wise for Pepsi to protect its turf via a purchase or an equity stake (along the lines of how Coca-Cola (KO) has amassed a stake in red-hot energy drink maker Monster Beverage (MNST) ).
Prime example of Pepsico earning its valuation gap vs. others in the packaged-food space.
Want an example of a solid "moat," check out Frito-Lay's lead over others in the important potato chip and tortilla chip categories.
Pepsico's Beverage Portfolio
Do soda volumes continue to be weak amid the shift by people toward less-sugary options? Of course. Is Pepsi behind Monster, despite having success with energy-enhancing drink Mountain Dew Kickstart? Yes. Has BodyArmor stolen some sales from Gatorade? Perhaps (though I am not sure why, in my opinion the stuff tastes horrible -- almost like medicine). But the reality is that the company's overall portfolio is working well as a unit -- meaning non-carbonated volumes are solid, while carbonated volumes remain soft.
Third-quarter operating profits for the North American beverage business rose an impressive 10%, lending support to the view that the business should be looked at as a unit -- instead of just as a soda seller.
As long as Pepsico could continue to drive solid sales of non-carbonated drinks -- and there is no reason to suspect it won't -- it's going to be hard to sell the stock (especially factoring in the Frito-Lay growth phenomenon).
The right part of the drinks portfolio continues to click on all cylinders.
