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On Oct. 3, ahead of the opening bell, the packaged foods giant released solid fiscal third quarter 2019 results that beat expectations and a slightly improved outlook for the remained of the year. Following a recent trend of mid-single digit percentage organic revenue increase, PepsiCo achieved top-line growth of over 4%, both on a reported basis and excluding the impact of currency and M&A. This was no easy feat, since the strong performance in 2018 made for tough comps in the current year.
Being Smart About Marketing
All of Pepsi's major segments, from North America beverage to Frito Lay and even Quaker, experienced positive revenue growth in the period.
Pricing strength seems to have played an important role in supporting the top line and gross margin. Meanwhile, volume declined mildly in the more mature parts of the business, including sugary drinks such as Mountain Dew. While some challenges could be observed in parts of South America, partly the result of macroeconomic softness in countries like Argentina, key emerging markets including Mexico and China saw revenues rise by more than 10%.
What stood out the most was the success of PepsiCo's product innovation efforts. For example, smaller brands within the Frito Lay portfolio, including the recent acquisition of Bare snacks, grew at a double-digit percentage rate. The recently-introduced Gatorade Zero also seems to have been a hit among U.S. consumers, as revenues surpassed the $500 million mark since the product's May 2018 launch.
Behind PepsiCo's robust financial performance seems to be its innovative marketing practices. The company has been focused on capturing and analyzing consumer data to better understand what and where to sell, and at what price point. Armed with better information, PepsiCo has been able to target smaller consumer groups who might respond better to the company's marketing efforts, and the positive results have been clearly showing on the top line.
To be clear, the approach has been putting a drag on margins, as marketing costs have risen at a faster pace than revenues. In the third quarter, adjusted operating expenses represented more than 38% of sales, compared to less than 37% last year. As a result, operating profit and earnings per share have not been growing much, if at all.
However, most shareholders will probably agree that investing in growth is a good use of the company's capital. PepsiCo seems to be taking the right steps to ensure that it continues to perform well across its product portfolio, gaining market share in most cases and better adapting to trends in packaged foods that favor lower calorie, more natural alternatives.
Being Even Smarter About Investing
PepsiCo has impressed once again by delivering growth in the generally mature space that is the packaged foods industry. As a result, shares should rise modestly in the near term.
Attentive investors might point out that the stock trades at a rich forward earnings ratio of more than 22 times and has been rising almost uninterruptedly so far this year, making for a pricey investment opportunity at current levels. However, PepsiCo's valuation seems to properly reflect the quality of the business and the company's encouraging growth prospects.
Also, the stock may be a great addition to a balanced portfolio, considering its defensive nature. Should U.S. equities continue to pull back or, even worse, experience a sharper correction in the foreseeable future, PepsiCo is likely to endure the headwinds much better than most other names in the market.
Given the combination of solid execution, strong fundamentals and the diversification benefits of the stock, PepsiCo looks like a compelling buy following the company's third quarter earnings report.
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The author has a long position in PEP.