The Long and Short
PepsiCo raises prices and reports higher revenue
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
PepsiCo kicked off earnings season with second quarter results well ahead of expectations on both the top and bottom lines. Top line growth was primarily driven by price increases in the company’s two largest businesses, Frito Lay North America and PepsiCo Beverages North America, with no impact on sales volume. Management raised full year-2022 guidance for a second time, despite their view that inflation will continue to rise in the second half of the year. The company also brought its leverage below 2.5x, which supports the current A1/A+ ratings. PEP looks like a high-quality core holding in the food and beverage sector.
While the company has a handful of short-term debt (duration less than 5yrs) that are trading below par and provide solid yield, management announced a new three-tranche deal with pricing concessions that provide an attractive entry point relative to secondaries. The new deal priced roughly 20 to 25 bp behind existing bonds, a nice concession for a high-quality single-A credit (Exhibit 1).
Exhibit 1. PEP Yield Curve
Source: Bloomberg TRACE; APS
Organic Growth Rate Led by Double-Digit Price Increases
PEP’s organic growth rate for the quarter totaled 13%, which was largely driven by a consolidated 12% increase in net pricing, while volume growth only contributed 1%. Even with a 14% increase in net pricing at Frito-Lay North America, volumes at the unit were flat year-over-year, meaning that pricing had little to no negative impact on volumes (Exhibit 2). Management witnessed a teens percentage rate of commodity inflation in the first half of 2022, and that they expect the rate to be slightly higher in the back half of the year. While PEP has been successful with price increases, they noted that they are also focusing on improved productivity levels, so that they are not forced to price all the commodity inflation through to the consumer. Price increases in the back half of the year are expected to moderate versus the pace witnessed in the first half of 2022, as PEP looks to take a more customer-centric approach in handling additional inflation and subsequent pricing.
Exhibit 2. PEP 2Q22 Subsidiary Organic Revenue Growth Rates
Source: Company Reports; APS
Credit Metric Strength Relative to Peers
PEP ended the quarter with adjusted net leverage of 2.3x, which puts it below management’s target of 2.5x. Leverage had ticked up after the company’s $3.85 billion acquisition of Rockstar Inc., which closed in April 2020. The timing of the acquisition was not ideal, as it closed at the start of the pandemic, which had leverage elevated for a longer than expected. The company repaid roughly $4.9 billion of debt in 2021, which helped reduce net leverage to 2.4x by year end 2021. Current net leverage of 2.3x compares favorably to KO, which stood at 2.4x. PEP’s leverage is lower than BBB peers, including Keurig Dr. Pepper (KDP), whose leverage currently stands at 3.1x. Interest coverage on a LTM basis improved to a very solid 14.8x, or nearly double the 7.7x level that PEP ended fiscal 2021 with.
New Issue in the Works
At time of writing, PEP was in the market with a new 3-part deal, looking to issue $2.5 billion across 5-, 10- and 30-year notes. The 10-year tranche is a green bond with proceeds to be directed to eligible green projects while the other tranches will be used for general corporate purposes. According to S&P, the proceeds from the 5-year and 30-year tranches will likely be used to largely repay commercial paper balances. That said, this deal is not expected to add too much to the current leverage ratio and leverage is expected to be maintained at roughly 2.5x or below. While the IPT was closer to 50 bp of new issue concession, the deal is expected to price with about 20 to 25 bp of concession relative to secondaries, which we believe provides an attractive entry point into the credit. While new issue concessions were essentially nil in 2021, the current volatility is beneficial for investors who are looking to the new issue market to put cash to work.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
