Q2 review, still modeling higher eps (PEP)
PepsiCo reported Q2 EPS of $1.86 vs. a consensus of $1.74 driven by a top-line beat. Constant currency EPS grew 10%. Organic revenue growth of 13.0% exceeded expectations of 8.1% driven by the international segments growing 15%. Global snacks grew 17%, while beverages grew 8%. Frito Lay organic revenue growth was 14%, but volumes were flat. Quaker Foods N.A. had organic revenue growth of 18%. Pepsi Beverages N.A. had organic revenue growth of 9%. International organic revenue growth was 15%, with strength in each region. Gross margins contracted 45bps after expanding 5bps in Q1. Frito Lay's core operating profit grew 5% despite higher commodity costs and freight costs. Quaker's EBIT grew 5% as higher commodity and freight costs, as well as marketing spend, led to margin contraction. Pepsi Beverages N.A. EBIT decreased by 3% due to difficult base effects and higher costs. Management raised organic revenue growth expectations for the year to 10%, from 8% but reaffirmed EPS growth guidance.
- Management attributed raising revenue guidance but not EPS guidance to unknowns in the economy, not new headwinds that were unanticipated earlier. Elasticity has not been worse than expected, so management felt comfortable taking revenue expectations up first.
- Management has not seen much consumer behavior change in the convenience and gas channel despite the higher gasoline prices. What little change they have seen has been in snacks more than beverages.
- Inflation is expected to continue to accelerate in the 2H, but productivity improvements are expected to as well.
- Pepsico is still looking for additions to its energy drink portfolio. A long-term partnership was not going to work out with Bang, so the company is moving on, but not from the energy category. The financial impact is expected to be immaterial.
- The LatAm business is benefiting from strong remittances and pandemic comparisons.
- Management was upbeat about the partnership with Boston Beer for Hard Mtn Dew, and with Starbucks for coffee. Management would like to make a few large consumer bets in the additional categories rather than with numerous brands.
Pepsico remains on our long list in Quad 4. We are modeling upside to current EPS projections for the year despite the worsening economic outlook due to the visibility of the growth drivers.
Adding to the long list (BJ)
We are adding BJ’s Wholesale Club to our long list. BJ’s Wholesale Club is a Quad 4 outperformer on an absolute and relative basis. Our macro team has increased the probability of Quad 4 for the next three quarters as time has progressed. It likely takes inflation and growth (as well as employment) decelerating faster than expected to avoid a Quad 4 environment in 2023. The economic data to be reported seems increasingly unlikely to alter the Fed’s path of tightening.
Food retailers benefited from the shift to at-home consumption during the pandemic. Just as COVID-19 restrictions were finally being lifted throughout the country and consumers were resuming their lives, food inflation and soaring gasoline prices have altered their behavior again. BJ’s Wholesale Club’s value proposition is positioned to gain share as consumers look to stretch their food budgets. BJ’s is an attractive capital preservation long for the quad environment with the highest probability of occurring. We see upside potential in both EPS estimates, and the multiple as the company takes share and accelerates new store openings.
We are presenting our BJ’s Wholesale Club Black Book on July 20th at 2 PM ET. We will update food retail industry trends, make our case for warehouse clubs gaining share within food retail, and examine new store performance to see if the company should accelerate store growth.
Stay tuned for additional details.
Returning the cash (PSTH, RVAC)
Pershing Square Tontine Holdings is returning $4B to investors after failing to find an acquisition target over the past two years. Management expected their scale and efficient capital structure to create opportunities for high-quality, large capitalization companies to go public. Universal Music Group was targeted, but the deal fell through over concerns brought by the SEC over the unconventional structure. Management also cited the extremely poor performance of SPACs that have completed deals and their high redemption rates. Given the current conditions, it is not surprising for the SPAC to return the capital. Due to Pershing Square’s history in consumer companies, especially consumables companies, it is a confirmation that IPOs are not happening CPG brands, vertical grow indoor farms, plant-based startups, or food delivery companies. Westrock Coffee is expected to de-SPAC in Q3 in an admittedly difficult environment for SPACs. The company has de-risked the IPO process by not requiring any proceeds from the IPO, but the capital will help the company's growth initiatives in the near term.
