PepsiCo Inc (PEP) — Q2 2022 Earnings Call Transcript

Thank you, operator. I hope everyone has had the chance this morning to review our press release and prepared remarks, both of which are available on our website. Before we begin, please take note of our cautionary statement. We may make forward-looking statements on today's call, including about our business plans, updated 2022 organic revenue guidance, and the potential impact of both the COVID-19 pandemic and the conflict in Ukraine on our business. Forward-looking statements inherently involve risks and uncertainties and only reflect our views as of today, July 12, 2022, and we are under no obligation to update. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to our second quarter 2022 earnings release and second quarter 2022 Form 10-Q available on pepsico.com for definitions and reconciliations of non-GAAP measures and additional information regarding our results, including a discussion of factors that could cause actual results to materially differ from forward-looking statements. Joining me today are PepsiCo's Chairman and CEO, Ramon Laguarta; and PepsiCo's Vice Chairman and CFO, Hugh Johnston. We ask that you please limit yourself to one question. And with that, I will turn it over to the operator for the first question.

Such strong numbers across the board. But I was curious if we could talk a little bit about the convenience and gas channel in the U.S. I know that you've noted on one hand, consumers are making more frequent trips to get gas which allows for more opportunities to go in and buy a snack or a drink. But on the other hand, they're spending a significant amount of money to fill up their tank, so there could be less extra money to spend when they go into the store. So I was just curious if you could talk about what you are seeing currently? I know C&G has been an area of incremental investment for you in the last couple of months, particularly on the Frito side. And just an update on the yield from those investments and what you're seeing in terms of consumer purchasing behavior.

Lauren, yes, listen, these are important channels you’re referring to, and we've been investing in the U.S. and other parts of the world in this impulse channel. The trends are quite stable from what we've seen since Q4. As gasoline prices went up, the consumption of beverages and snacks in that particular channel has been pretty stable. A bit less volume, a bit more price as we compare the second quarter to the first quarter. But overall, sales have remained stable, high single digits, with a bit of difference between beverages and snacks. Snacks are performing a bit higher than beverages, but remain stable. This trend has continued into the last few weeks. So we don't see any meaningful consumer behavioral change as gas prices rise. Obviously, we're watching this channel very carefully as an indicator of potential consumer behavioral change, but so far, we're seeing high incidents in our categories.

I just want to talk a bit about pricing relative to costs. Obviously, another quarter of very exceptionally strong pricing in Q2. Ramon, are you hearing any pushback from the retailer trade that’s different than normal? It's been a topic of discussion more in CPG in general. So just curious for your views on retailer pushback and ability to continue to take pricing going forward, including what that might mean for the fall. And then Hugh, can you just give us an update on the cost outlook for 2022? And given hedging, how much hedging do you have in place? Does that create a hangover for '23? I know you won't guide for '23, but just how you think about the pricing versus cost gap for '23 based on where we stand today might be helpful at least conceptually.

Yes. Dara, yes, obviously, our partners and ourselves are looking at consumers very carefully and the evolution of their decisions when it comes to the overall basket or particular categories. Typically, we have pretty positive conversations with our partners, and we're exploring how do we continue to keep our consumers engaged in our categories as we need to pass some of these costs to the consumer. We're working on ways to do this without significantly impacting volume, generating growth for both of us. We are all concerned about high inflation and how it will impact especially the lower part of the income pyramid. We are making strategic decisions regarding entry points in the categories to keep that particular consumer engaged. The conversations we have are always characterized by some tension, but in general, they are quite positive, as we aim to be growth drivers for our partners.

Right. Dara, in terms of cost, our first focus whenever we're faced with inflation is to drive incremental productivity in our internal costs. We’ve seen some of the strongest productivity this year that we've seen in several years. This places us in a relatively better position against commodity inflation because we are not necessarily forced to pass all costs through to consumers. We can adopt a more consumer-centric approach to managing inflation and pricing. The inflation we expect in the second half is higher than in the first half. As noted before, we’re experiencing commodity inflation in the teens. That will continue but we also expect stronger productivity in the back half. Overall, our guidance captures all of that, and we have high confidence in delivering the year.

So the market share gains you alluded to in snacks, and in general, we’ve been pretty positive. I know there have been some service level issues in both cases, especially in North America. I'm wondering if you can comment on that. Separately, in LatAm, I think you mentioned Ramon and Hugh, in terms of balancing what you just said, inflation is getting worse. Of course, Latin America has been extremely resilient for a region that has a lot of pressure from gas prices as well. I wonder if you can comment on where the strength is coming from, if you're gaining more space in large box stores, or if it’s also Bodega Aurrerá or Atacadão or anything that gives you comfort that you're continuing to gain share on an organic basis despite pricing? Could you also comment on the service levels in the U.S.?

Great. Okay. Thank you, Andrea. I'll talk about share in a moment. If you think about our responsibility, referring mostly to snacks, but applicable to beverages as well, our #1 responsibility as a large player is to ensure our categories grow under any circumstances, whether economic conditions are positive or negative, high inflation or low inflation. That is essential for the health of the business. Everything we do in our commercial plans, both in the U.S. and internationally, is aimed at ensuring that our categories remain preferred among consumers despite various economic pressures. We're delivering strong growth with low elasticities in many countries, and this reflects our effective commercial programs, which attract consumers to our brands through innovation and execution. Regarding market share, we are seeing gains across many countries, thanks to several years of investment in strengthening our go-to-market capabilities and digital strategies. Your question regarding Latin America relates to money transfers from the U.S. into Latin America, which are quite high due to robust employment and higher salaries in the U.S. This is positively affecting disposable income in those countries. Surprisingly, we are observing very low elasticity, even as we pass on price increases. Disposable income in Latin America is higher than before, positively influenced by strong economies sending money into the region. We’re also witnessing a social shift post-COVID as consumers begin to socialize again, driving higher category consumption.

All right. Maybe, Hugh, if you could just talk a little bit about headwinds and tailwinds in the back half of the year. I guess it's in the context of you raised organic sales guidance this morning but kept the EPS basically the same. Is that a function of concerns about costs? I know you mentioned some of that in response to Dara's question, foreign exchange volatility in the world. Just how you think about maybe some of the risks or headwinds and tailwinds that might have evolved as you look into the second half?

Yes. Bryan, obviously, the first thing we're watching these days is the level of volatility in the world. We attempt to insulate ourselves against this volatility. We have zero-floating rate debt and we forward buy on commodities, mitigating our exposure. We try to create a predictable work environment so we can manage labor costs effectively. However, there are macros that are more volatile today than a few years ago. As we consider the future, commodity costs are anticipated to be higher in the back half than in the first half, which we’ve factored into our planning. We're closely monitoring elasticities, which are currently strong. However, we don’t expect them to remain as solid in the back half, given the inflation impact on consumers.

All right. Just a quick follow-up on what you were discussing, Hugh. Could you talk about whether you are planning to reinvest or increase reinvestments into your business despite the cost inflation you called out in the second half? I'm thinking about in the context of your very strong top line. I did want to ask about your revenue growth management in this environment and how strong you think your capabilities are to ensure you have the right packages in both your beverage and salty snack businesses to guarantee affordable offerings, especially as we could see increasing pressures on consumers. Lastly, could you touch on your beverage business and how your ownership of your bottling operations might actually be a competitive advantage or not, as it relates to this?

Okay. Thanks, Bonnie. I think that was three questions, but we'll take a shot at it. First, regarding investment in the back half, we have some planned investment. We're trying to run the company to build sustainable results over the long term. That means constantly balancing delivering near-term results while also building capability for the future. We believe we have the right balance right now, and we'll adjust as necessary based on results. On your second question regarding consumer value, I think we are well-positioned in the industry to offer a broad portfolio, from premium products like Frappuccino to value products like SANTITAS. Our supply chain enables us to tailor inventory based on store needs, adjusting for stores in need of value products or those expecting premium products. Our digital investments in our route systems enhance our capability in this area. Regarding the ownership of our beverage business, I’ve reiterated in the past that it is a significant competitive advantage for us. While it is more capital-intensive, it allows us to execute strategies that are difficult for competitors. We believe our strategy will be validated more than ever in this environment.

Yes. Especially Bonnie, I think on your second question, we’ve invested in revenue management for 4 or 5 years. It has been focused not just on developed markets but also on emerging markets to enhance old capabilities relating to product size or channel understanding with a more precise individual understanding of consumer preferences. This links to our precision execution, as Hugh mentioned, across all markets. We have a unique advantage end-to-end from consumer insights to point-of-sale execution, which is hard to match. We're seeing the benefits of these investments worldwide, which are allowing us to stay agile and responsive to consumer preferences, especially as inflation continues to rise.

Ramon, I was wondering now with the decision on the bank distribution rights out, can you just update us on the energy drink strategy here? What kind of financial implications should we expect as we think about your beverage business over the course of the year now, considering I'm not sure if the distribution stops right away or if you still have some time left on the contract?

Yes, Nik. Our commitment to the energy category remains strong. We see this category as one that is growing and where we can capture sub-segments. Our multi-approach continues to be valid. We're leading with Rockstar, which is performing well across several platforms including non-sugar and functional beverages. Our coffee business is also a key pillar, with Double Shot and Triple Shot performing well, alongside our innovative partnerships with Starbucks. The third pillar is our flavor-forward energy with Mountain Dew, and we're seeing growth in the Sports & Energy segment. The distribution part has always been additional, but our strong DSD system allows us to bring brands into our portfolio effectively. Bank’s relationship didn’t start strong, and discontinuing it is a better long-term decision with no significant financial implications as it was not central to our energy strategy. Our primary focus remains on executing our own strong brands and capturing market share.

Great. Ramon, I wanted to pivot to your business venture with Boston Beer and Hard Mountain Dew. Could you provide an update on how that relationship has progressed since the partnership was announced, what your early learnings are? As you study the alcohol space in depth, could you share updated thoughts on your broader ambitions to play a bigger role there, especially regarding new product innovation and the potential to distribute non-PepsiCo products through your distribution?

Yes. Nothing has changed since last quarter regarding our partnership with Boston Beer. We’re increasingly convinced of the potential of Hard Mountain Dew, which has been developing well. We licensed the brand to Boston Beer. Our distribution efforts are succeeding in several states. Execution has been strong, and market share in those states reflects positively on the partnership. We’re motivated by this success, and we’re working on multiple innovations that will come to market soon. While we aim to leverage our distribution for alcohol, we do not want to handle numerous brands; we prefer focusing on a few significant consumer opportunities to maximize our impact through our DSD system.

I was hoping to dive into consumer preferences, please. You've consistently mentioned aspirations to shift your portfolio towards reducing fat, lowering sodium, and sugar propositions. Given the last 2.5 years, especially at the pandemic's onset when consumers leaned towards indulgent offerings, have you seen a mean reversion in consumer preferences towards health and wellness propositions in your portfolio?

Yes. Vivien, I'll share some data to help with your analysis. In beverages, non-sugar products are growing three times faster than full sugar. This indicates a shift in consumer preference in the U.S. In developed markets like Western Europe, the trend is also clear, with non-sugar beverages comprising almost 80% of the market in the UK. We're investing in innovations like Gatorade Zero, which has generated $1.5 billion within three years, attracting new consumers to the brand. The trend towards non-sugar beverages is unstopable, and we’re committed to leading with R&D in this area. In snacks, consumers are also choosing healthier options. 'Permissible snacks'—baked or popped rather than fried—are growing faster than fried options. We're also gaining traction on smaller portion sizes, promoting more variety and appealing to health-conscious consumers. While indulgence and functionality remain relevant, I predict health will continue to be a significant consideration for consumers, and our strategies will be aligned with these trends.

Maybe going back to the higher top line that you're now seeing for the year, could you expand a bit more on that? What incremental changes have occurred in your expectations since last quarter? Would you frame the points of organic growth upside more as volume-driven or price/mix relative to prior expectations? Are there any particular segments that stand out as being especially responsible for this?

Yes. To answer your question directly, there is nothing new that we weren’t aware of a couple of months ago, so I wouldn't characterize this as conservatism. We're always careful not to miss numbers. The primary reason for the revenue increase is the strong performance of elasticity as we came out of the first quarter. The second quarter showed better elasticity than expected and we are integrating that positive flow. However, we still have six months left in the year, many uncertainties ahead for consumer behavior. We plan to remain well-positioned for both our customers and consumers, but we haven't ruled out potential volatility.

You've made a decision a few years ago to retain the bottlers you purchased a while back. In this inflationary environment, does that change how you think about how asset-light or asset-heavy you prefer your business model to be?

No. Listen, inflation will come and go. The reason we're keeping the bottling business integrated with the brand business is a strategic decision intended for the long term, looking beyond economic cycles. Integration provides flexibility and a decision-making advantage that adds value to our operations. While inflation affects us in various capacities, it remains constant across the consumer journey. Therefore, the strategic choice to integrate our bottling system with our brand operations is focused on future demand. Economic fluctuations matter less to us compared to developing a robust ecosystem for consumer engagement and fulfilling demand in a way that keeps us ahead over the next 5 to 10 years.

From the data that we can see, your top line is benefiting by about 100 basis points from reductions in promotional depth and breadth. This trend does not appear to be short-term; it has emerged over the last several years. We can see parts of your business benefitting. Could you speak to the benefits from promotional optimization across your business? What's enabling that realization? Given the enormous size of promotional spend in your business, how do you view the medium-term potential for promotional optimization?

That's a great question. We are evaluating all costs in the company, both to fulfill and generate demand, focusing on achieving higher returns on investments across the board. We’re optimizing our promotional budgets alongside our marketing investments. This has been a journey rooted in enhanced intelligence and data-driven decision-making, and we’re continuously evaluating ways to maximize returns. Trade budgets are significant, and we’ll continue optimizing them, possibly reallocating those resources to areas yielding better demand generation in partnership with our customers.

I have a couple of questions on some topical markets. In Europe, are we finally seeing consumers come down a bit? As pricing increases, are other factors beginning to impact volumes, such as supply chain issues or product availability, apart from consumer elasticity? In addition, regarding China, despite lockdowns, we've seen another strong number. Can you give us insight into the on-ground situation in China that is enabling this level of growth?

In Europe, the situation is indeed impacted more than other regions by the ongoing conflict, particularly in Ukraine and Russia. In Ukraine, we had to halt many manufacturing and commercial operations, which is reflected in our performance. In Russia, we’ve committed to reducing certain operations and cease advertising for essential food brands, affecting our European business. Regarding China, lockdowns have posed serious operational challenges. However, our teams have adapted remarkably, enabling us to maintain production of snacks and beverages despite difficulties sourcing raw materials. We are managing these issues better than many competitors, allowing us to gain significant market share. In beverages, consumption is affected due to the lockdowns reducing away-from-home sales, though in-home beverage consumption remains strong.

I hope to follow up on Nik's question about the energy portfolio. Ramon, you mentioned the potential to leverage your distribution assets. What major lessons did you learn from the relationship that inform your approach to future agreements? Also, how do you see the timing: is it a near-term focus to find a new brand to fill that gap, or is this something you are considering more opportunistically?

The distribution aspect of the energy strategy remains relatively marginal compared to our core strategy. Moving forward, we will continue to focus on Rockstar and leading our category with strong brands. The opportunity to capture market share is crucial as we witness consumer trends evolving. We have a robust pipeline of innovations and strategies shaping our future direction. Lessons from our experience with distribution underscore the importance of successful long-term partnerships. Our aim is to optimize our strategy while being opportunistic in harnessing future lucrative partnerships that align with our consumer pulled direction. Thank you, everyone, for joining us today. I appreciate your time, especially during the summer season when everyone has lots to do. I also want to thank you for the confidence you have shown in your investment in PepsiCo. We hope you are all safe and healthy and enjoy the summer.