Pepsi Looks Cheap After Mostly Solid Quarter
We're maintaining our long-term outlook for Pepsi, and see shares trading at an attractive 15% discount to our fair value estimate.
While Pepsi’s (PEP) food and snacks business posted strong results in the first quarter (with organic volumes up 3%), the North American beverage business continued to be a drag on its top line (with volumes declining for the third quarter in a row).
However, our view of the firm’s wide moat remains unchanged, and we contend management’s heightened focus on restoring growth in the North American beverage portfolio, ongoing innovation in the snack and noncarbonated beverage categories, and strong performance abroad will fuel further top-line growth as the year progresses.
Organic sales grew 2.3% (a touch below our annual expectation of 3%) and gross margin contracted 110 basis points to 55% (matching our estimate for the year) on input cost inflation, which has plagued companies across the consumer products space this quarter. Although we may make slight adjustments to our segment-level sales forecasts for the year, we’re maintaining our long-term outlook, which calls for around 3% sales growth and operating margin in the high-teens (versus a 16% average over the past three years), and don’t foresee a material change to our $123 fair value estimate. Shares are trading at more than a 15% discount to our valuation, which we view as an attractive entry point for long-term investors.
Within North America, sales were driven by continued strength in Frito-Lay, with revenue up 3% (two thirds of which was driven by price/mix), matching our forecast for the year. We view this rate as sustainable over the next several years, as consumers’ penchant for convenience boosts snack consumption and product innovation allows for modest net pricing increases. Results were less rosy in the Quaker Foods North America segment (flat sales), as a secular shift away from center-store food categories has led to tepid volumes and flat to slightly negative pricing over the last several years. In this vein, we expect average sales in this business to remain flat over the next five years.
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Sonia Vora does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.