Industry watchers believe the rest of the year will be challenging for PepsiCo

Industry watchers believe the rest of the year will be challenging for PepsiCo

At first glance, PepsiCo's second-quarter figures looked solid enough but industry watchers believe the rest of the year will be challenging for the US group, with continued currency pressure, macroeconomic volatility and high commodity inflation. Here's our take on PepsiCo's numbers, recent performance and the outlook for the business.

1. Tough second half ahead

Foreign exchange hit PepsiCo's reported second-quarter numbers but, excluding the impact of currency fluctuation, sales and profits were up - and the US giant also lifted its forecast for annual earnings.

However, shares in PepsiCo fell yesterday, with the outlook for the rest of the year looking challenging. Bonnie Herzog, an analyst at Wells Fargo Securities, said she was "not surprised by the market's tepid reaction". She added: "We believe our cautious read heading into Q2 results will likely continue to play out for the balance of the year given higher commodity inflation leading to moderating gross margin expansion; difficult comps; continued currency headwinds and ongoing macro-economic volatility." PepsiCo CFO Hugh Johnston explained the company is expecting a "back half lapse" where the third and particularly the fourth quarters are more challenging. Commodities are expected to be "more of a headwind" in the back half of the year and PepsiCo is likely to continue to see volatility in key markets such as Russia and the Middle East.

2. The European lag

Taking the markets specifically, PepsiCo is experiencing some pressure in Europe - geopolitical issues in Russia and the rise of the discounter in the UK just two examples. "Being one of the major food and beverage companies in the UK... I think we have to be careful how we make our transition with the high street retailers and the discounters," explains CEO Indra Nooyi. She admits the company has lost some share but has plans in place to recover that. "As we see major changes in the retail environment, always in the short term, there will be some dislocation, because we have to make changes in the business model very-very carefully." On Russia, despite "wishing" there were no geopolitcal issues to deal with, PepsiCo expressed confidence in its business in the country. "We play a very judicious game between revenue and profits," asserts Nooyi. "And we have been playing that game very-very carefully, and if you look at our year-to-date numbers...we are performing at or above our expectations in Europe, and we feel comfortable at what the team is doing, and that's what we intend to keep doing for the balance of the year."

3. Good growth in developing and emerging markets

Developing and emerging markets delivered 11% organic revenue growth in the quarter. Turkey and Saudi Arabia achieved double digit organic revenue growth. China - notably, given recent peer performance - Egypt and the Philippines achieved high single digit organic revenue growth and Mexico achieved mid-single digit organic revenue growth.

4. The LatAm shake-up

But it was Latin America that attracted the most interest during the call. Prior to its results announcement, PepsiCo revealed the appointment of Laxman Narasimhan, the CEO of PepsiCo's Latin America Foods unit, to lead an integrated food and beverage business across the region. The company's food and beverage businesses in Latin America will be combined and reported as Latin America, creating a Latin America segment consistent with PepsiCo's other international segments, which are managed as integrated food and beverage businesses. PepsiCo said the move would help it "leverage the scale" of its brand portfolio and "enable greater synergies". Nooyi said the company had seen success in Europe and AMEA with " all of the power of one management of those regions. It means more productivity takeout costs "and especially with volatile economies, we have to get more and more agile and more creative about how to take out costs," she said. Some industry experts have applauded the move. Ken Odeluga, senior market analyst at CityIndex, said the news should be read as a "tacit signal that apart from Venezuela, the rest of the region is coming along satisfactorily".

5. The right people in the right places

PepsiCo also revealed a series of management changes, including the departure of its global categories and operations chief. And people placement is clearly an area of importance to Nooyi and the board. "Our focus is two-fold here; making sure we have the right leaders in place today, and that we are developing the next two generations of leadership for the company." PepsiCo apparently has 200 "critical leadership" roles within the company - the ones it terms are most important to its success. It is creating a pipeline that safeguards it as people transition in and out of the business. The pipeline comprises one immediate successive candidate; two people in a one- to three-year timeframe; and then another three people ready, four to six years out. "As a result of this process, we are deliberately developing top talent, by giving them multiple category, geography and job experiences and ensuring we have well developed succession plan," says Nooyi.

6. Snack appetite

Nooyi noted PepsiCo still has a lot of room to grow in snacks. The company has come a long way; starting out from a salty crisp snack background to having a portfolio of savoury snacks including crackers, nuts and seeds. "There is a lot of opportunity there," Nooyi said.

One move which has paid dividends so far is the collaboration between its drinks and snacks portfolio. PepsiCo has specified two areas in which to grow within snacks. The first is a "compliment to our snacks" - something which made them venture into dips with Sabra. "We still haven't scratched the surface, and we have got lots of growth," explained Nooyi. The second is taking away eating occasions from other macro-snacks category - that is the snacks between meals. "Our goal is to...look at each eating occasion by cohort group, and figure out, how we can leverage our salty snack platform, to go after other macro snacks [either] replace it with a salty occasion, or do some sort of a salty-sweet combination, for example Stacy's with cinnamon sugar. It's based on a pita chip, but it's certainly sweet when you taste it, and has a much better mouth feel and experience, than if you eat something totally sweet by itself."

7. Innovation

It was the topic that dominated much of the discussion on yesterday's conference call. Much of the company's success in innovation has come from "significant investments in and changes" to its innovation research and development capabilities and processes that began eight years ago, explained Nooyi. PepsiCo "undertook a major transformation to improve our R&D function and innovation capabilities." This has included establishing global category groups charged with coordinating global innovation; the launch of its "Demand Moments" framework which focuses on the triggers of consumption by examining consumer needs based on the context of the occasion; facilitating quicker "lift and shift" of successful innovation launches from one market to another and increased investment in R&D among other things. "We are particularly encouraged by PepsiCo's investments in R&D which have helped PepsiCo increase innovation as a % of total revenue to 9% in 2014 (up 150 bps since 2012)," said Herzog. " Over the past three years, PepsiCo has introduced a number of new products that now generate more than $100m annual retail sales and has leveraged premium innovation to deliver more price realisation."

8. On trend: health and wellness

Innovation has extended to the health and wellness category, too. The company said it has recognised that consumers are "embracing" things like almond milk and other plant-based protein alternatives to traditional milk. Under its Naked Juice brand, PepsiCo has launched Berry Almond Nut Milk and Peachy Almond Nut Milk.

9. On trend: convenience

The firm has also responded to the need for quicker eats - particularly when it comes to breakfast. Many breakfast competitors - Kellogg for example - have struggled to retain market share as consumers find themselves more pressed for time in the mornings. PepsiCo, using its new "Quick Cook Steel Cut" innovation has seen it enter the number one market position in the "on-trend and growing Steel Cut Oatmeal segment by making preparation more convenient". Moves such as this have seen PepsiCo's Quaker Foods division gain value share in hot and ready-to-eat cereals.

10. Productivity savings

Of course, its not just been about investing for PepsiCo in recent quarters. The company has a goal of delivering $5bn in productivity savings from 2015-2019. This follows an aggressive three-year $3bn programme which concluded in 2014. But on the call, Nooyi insisted PepsiCo was balancing top line and bottom line growth "very-very judiciously". "When you embark on a zero base budgeting program that cuts to the bone, and jeopardises your ability to grow the top line. I think that's a formula for disaster. We believe into the smart spending initiatives where we look across all of our cost structure, and say where we can selectively reduce costs, intelligently, not for the short term, but find a way to make sure it does not affect top line growth initiatives."