The Long and Short
PepsiCo raises prices and reports higher revenue
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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.
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