Pepsi's Growth Story Was All About Pricing

 PepsiCo (PEP) continued to post solid price-driven organic revenue and profitability growth in its second quarter, and we are likely to raise our fair value estimate by $1-$2 to account primarily for the time value of money since our last update.

Overall, the firm executed against its cost-saving plan, particularly in its Frito-Lay North American segment, and operating margins (excluding restructuring and other charges) ticked up 62 basis points from a year ago. Frito-Lay remains the firm's most profitable segment, but after stripping out the sharply negative impact of foreign currency headwinds, which dragged down revenue and operating earnings growth 10 percentage points across the entire company, we're encouraged that the PepsiCo Americas beverages division also saw adjusted operating profit grow considerably faster than sales.

The consolidated company saw reported operating margins improve to 18.2% from 17.1% in last year's second quarter, and management now expects core earnings per share growth of 8% (versus 7% previously). We will tick up our near-term projection to account for this strong performance, but overall we remain comfortable with our long-term projection that the company can drive full-year operating margins to nearly 16.5% versus 15.5% in 2014.

However, volume growth slowed to a halt in the second quarter; positive net pricing drove nearly the entirety of the firm's 5% organic revenue growth year over year. We're particularly concerned about zero volume gains in Frito-Lay--the first such reported figure since mid-2012. Admittedly, price was a particularly strong contributor for the segment during the quarter (up 3%), and management noted newly introduced smaller package sizes drove this dynamic, leading us to maintain our forecast for more-balanced growth past this year. That said, the business has an outsize impact on PepsiCo's consolidated results, given it makes up nearly a third of division operating profit.

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