One of the most anxiously anticipated earnings results for the third quarter is Pepsico (NASDAQ:PEP). While management has focused on reinvigorating the brand, and producing relevant products Pepsi stock hasn’t exactly generated much confidence. Before heading into Q3, PEP shares had dropped more than 5% for the year.
Nor is this underperformance an isolated matter. Over the trailing five-year period, PEP stock has returned only 39%. In contrast, the benchmark exchange-traded fund SPDR S&P 500 ETF Trust (NYSEARCA:SPY) delivered nearly 73% profit over the same period. Additional concerns rest in the sector’s broader weakness. For instance, Coca-Cola (NYSE:KO) badly lags Pepsi since five years ago.
The primary headwind for Pepsi stock is shifting consumer habits in the North American market. While the company of course levers a vast international presence, the bulk of sales come from the domestic market.
Last year, Pepsico’s beverages sold in North America accounted for 33% of all sales. Next comes Frito-Lay, the company’s food and snacks division, at 25%. In third place is the Europe and Sub-Saharan Africa market, but at a distant 17%.
Therefore, the common thinking is that Pepsi must decisively win its home games for PEP stock to look great again. Unfortunately, it will take a presidential effort for the beverage-maker to succeed in the current paradigm.
We’ve seen report after report confirming that the contemporary American consumer prefers healthier beverages. This is a dramatic shift in sentiment from generations ago, when drinking a can of Pepsi was almost a rite of passage.
However, the company isn’t taking things lying down. Management has aggressively pursued the sparkling-water market — a millennial favorite. Earlier this year, PEP launched “Bubly,” which features eight flavors and no added sweeteners.
But will this sweeten the deal for Pepsi stock? Let’s find out:
Pepsi Earnings Delivers on the Top and Bottom Lines
After an encouraging Q2 report in which Pepsi earnings topped estimates, investors looked for more of the same in Q3. The actual metrics gave everyone something to think about.
Consensus estimates pegged earnings per share at $1.57. Individual estimates ranged from $1.53 to $1.65. Actuals came in at $1.59, or a positive surprise of 1%. In the year-ago quarter, the company delivered an EPS of $1.48.
Additionally, the beverage-maker registered $2.49 billion in net income, or $1.75 per share. Year-over-year, this is an increase of 16% from $2.14 billion, or $1.48 per share.
On the revenue front, consensus called for $16.36 billion. Analysts had a wide range of opinions, from a low of $16.2 billion to a high of $17 billion. The actuals came in at $16.49 billion. In Q3 2017, PEP rang up $16.2 billion.
The most important metric of the Pepsi earnings report, though, was North American beverage sales. After years of intense pressure, management decided to throw their marketing weight behind their Pepsi, Gatorade and Mountain Dew brands. Their efforts paid off, with the domestic market gaining 2.5% in organic growth. In the previous quarter, this metric slipped 1.5%.
The victory was especially meaningful for Pepsico CEO Indra Nooyi, which was her last day at the helm. Nooyi has resisted calls to split the company’s beverage business, believing that Pepsi stock is stronger as a complete entity.
She is likely right. Unfortunately, the one conspicuous blight on the Pepsi earnings report was that PEP stock didn’t receive a sentiment lift. Shares shed more than 1.5% in premarket trading before clawing back some of the losses.
Investors worried that the marketing efforts will drag future profitability. Also, management softened full-year earnings guidance from $5.70 to $5.65 due to the stronger dollar’s negative-currency impact.
Beverage Market Might Surprise Pepsi Stock
Undoubtedly, the volatility in Pepsi stock is a downer. Wall Street still lacks confidence in the beverage market thanks to prevailing consumer reports that proclaim the soft drink’s demise. However, the situation may not be as bad as advertised.
Last year, a consumer survey asked Americans about the frequency of their soda purchases. Surprisingly, the majority of respondents, or 32.2%, stated that they purchase the bubbly stuff a few times per month. Coming in a fairly close second place are those who buy a few times per week, at just under 26%.
Americans who don’t buy any soda at all are in the clear minority at 15%. Those who only purchase a few times per quarter represent 7.1% of the population. Thus, we’re close to the 80-20 rule in favor of PEP stock.
That doesn’t mean that Pepsico has an easy road to recovery. But what we could be dealing with is a marketing problem instead of a structural crisis. Consumers here still love their soda. Sector players must find a better way to reach out to them, though.
All told, this is a lot better situation than Americans completely abandoning their soda habit. Therefore, keep close tabs on Pepsi stock. This is a contrarian opportunity that many are ignoring.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
