PepsiCo Inc's Q3 Earnings Rise on Modest Revenue and Margin Improvements

"Pepsi Cola" image by Nomadic Lass under Creative Commons license.

So far in 2014, a tepid global economy is challenging but not defeating PepsiCo. The snacks and beverage conglomerate today reported third quarter 2014 earnings, posting an increase in revenue of 2% and net income growth of 5% versus the prior year. The company's Earnings Per Share, or EPS, increased 7% to $1.32 per share. PepsiCo raised guidance for its adjusted, or "core" EPS growth for 2014, from 8% to 9%. This increase comes off the back of an upward adjustment last quarter, in which the company raised full year core EPS guidance from 7% to 8%.

PepsiCo grew organic revenue by 3.1% during the quarter. While this continues a string of organic revenue increases, it's slightly below the recent trend, bringing total year-to-date organic revenue growth down from 4% (at the end of the last quarter) to 3.5%. 

The company's net income increase of 5% versus the prior year was driven largely by lower interest expense, higher interest income, and lower income tax expense. Operating profit (profit before these items) increased just 2% versus the prior year's quarter. Gross margins improved roughly 50 basis points, or one-half of one percent.

Outperforming divisions
Peeling back the onion a bit, PepsiCo's results were propelled by stronger revenue and profit in three divisions: Frito-Lay North America (FLNA), Latin America Foods (LAF), and Asia, Middle East and Africa (AMEA). FLNA, the company's North American snack business, expanded revenue by 3%, and operating profit by 5%. As I discussed in a recent article, FLNA, at one-fifth of total company revenue, is benefiting from cross-promoting its popular snack products such as Doritos with drinks from its beverages division (think of heavily promoted Mountain Dew) in retail environments.

LAF, PepsiCo's Latin American snacks division, also posted pleasantly vigorous revenue and profit numbers, with increases of 6% and 11%, respectively. PepsiCo's strategy in Latin America has been to "price in" to some of the higher inflationary environments such as Argentina and Venezuela. That is, as inflation rises in these countries, the company adjusts its selling prices upwards, evaluating constantly how far it can match inflation before impairing demand.

A third bright spot this quarter was the company's AMEA division, which ramped up revenue by 11% and operating profit by 5%. While AMEA, at $6.5 billion in annual sales, is PepsiCo's next to smallest division, it represents future growth potential. The company recently opened its first R&D facility in the Middle East in Dubai, to modify PepsiCo product flavorings for Middle Eastern consumer preferences. In another sign of this region's potential, the International Monetary Fund projects that Sub-Saharan Africa will be the highest economic growth region outside of China and India in 2014 and 2015.

A few stagnant spots
As a counterweight to divisions which gained momentum during the quarter, Quaker Foods North America (QFNA), PepsiCo Americas Beverages (PAB), and Europe dragged on revenue, with QFNA declining 3%, PAB remaining flat, and Europe slipping 1% versus the prior quarter.

Each of these divisions has struggled to post revenue gains over the last several quarters. A brighter prospect is found in the operating profits of Quaker Foods and PepsiCo Americas, which were able to show operating profit gains of 9% and 2%, respectively. The two segments were likely beneficiaries of PepsiCo's productivity plan, which will deliver $1 billion in savings in the current year on a companywide basis.

Notably, PepsiCo Americas held the line on its carbonated beverage volume, which decreased 1.5%. As we mentioned in our earnings preview, the North American beverage division must manage the declines of its carbonated soft drinks revenue as consumers turn toward healthier options. The 1.5% soft drink retracement is actually a small improvement over the previous sequential quarter, which saw a 2% decline. At 33% of total company revenue, this division must hold the soft drink shrinkage to within a percentage point or two each quarter, while gradually expanding non-carbonated volumes -- a feat it achieved this quarter.

The Europe division reported an operating loss of 7% during the quarter. The near-halt to economic recovery on the European continent, combined with geopolitical uncertainty in Russia and the Ukraine, may continue to drag on the division's results in the near future. Shareholders will want to keep an eye on the results of this division going forward, which, like FLNA, accounts for one-fifth of PepsiCo's annual top-line.

Was this a strong quarter for PepsiCo?
While you may read that the beverage and snacks giant "beat expectations" on "Core EPS" this quarter, the unadjusted numbers discussed above, focusing on items relevant to long-term shareholders, show a more modest result. Nonetheless, it's to management's credit that the company has reported another quarter of rising revenue and net income in what is undoubtedly a tough macro environment for multinationals. Investors should appreciate the focus on productivity and cost control which is allowing Pepsi to continue to expand margins, even as revenue, buffeted by currency headwinds and cautious consumers, inches along.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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