PepsiCo Inc (PEP) — Q2 2023 Earnings Call Transcript

Thank you, operator and good morning, everyone. I hope everyone has had a 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 and updated 2023 guidance. Forward-looking statements inherently involve risks and uncertainties and only reflect our view as of today, July 13, 2023, 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 2023 earnings release and second quarter 2023 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.

Thanks, operator. Hey. Good morning, Hugh. Good morning, Ramon. So I guess, Ramon, my question is more related just to how you're looking at the bigger macro picture in the consumer specifically. I think as we went into this year, there was an expectation that elasticity would increase and there'd be more of a consumer response to all the inflation we're seeing really globally. So I guess it seems like in the first half volumes effectively have been better than expected. So I guess as we're kind of looking forward in the back half of the year and even into next year. Can you just kind of give us a little bit of insight into how what you're seeing with the consumer? What your expectations are and just how that may have differed from what we were seeing or what you were thinking maybe going into the start of the year?

Yeah. Good morning, Brian. So I'll give you two areas we are looking at very carefully. One is on the supply side; things have become much better. We're seeing a much better flow of materials from suppliers and, in general, a better labor market, which has helped us to run a better company. During COVID, it was not perfect; it's becoming better and that's why you will see that our costs are performing better. We're slowing some of the net revenue down into the bottom line. On the consumer front as well, we were planning the year with more historical data on elasticities, both in developed and developing markets. We're seeing better elasticities and that has continued to be evident in the first half of the year. Even though we're seeing lower-income consumers strategizing around obviously optimizing their budgets, we're seeing the majority of consumers staying within our categories and our brands. Our marketing and commercial teams have been doing remarkable work to minimize elasticities. It is what we have been investing in for the last few years. Our brands are stronger. The perceived value of our products is better than it was. We've been able to raise prices and consumers stay within our brands. We're seeing consumers making some adjustments; they're shopping in more stores than before, looking for better deals and optimizing their spending by going to channels that have better perceived value. Overall, we’re seeing very positive trends; it has to do with the low unemployment levels in most economies, both developed and developing markets. We're seeing overall very good consumer behavior, especially when it relates to our categories and that's why we raised guidance on our top and bottom lines.

Hey, thanks. So maybe can we just extend that question a little bit? You mentioned some of the strength in Mexico. International came in very strong in general in the quarter. Obviously, you have a lot of different countries and regions within that and two distinct businesses. But just high-level thoughts on what drove the international strength and the state of the consumer internationally? And then I'm thinking particularly about the pricing side of things. Obviously, we're sort of cycling tougher comps going forward, globally, not just internationally. But can you also give us an update on the competitive environment you’re seeing around the world heading into a period when, in theory, pricing drops off as we cycle these tougher comps? Thanks.

Yeah. Thank you, Dara. There are obviously some markets around the world that are suffering from currency issues and we must adjust to that reality, like in Turkey, Pakistan, Egypt, and Argentina. But beyond those markets overall, we're seeing, and I think it's because the unemployment levels are very low. Consumers continue to behave positively. Our category penetrations in most of those markets are still relatively low, and we continue to be an affordable option for consumers in those regions. Therefore, we're seeing positive developments. In terms of the competitive landscape, there’s very rational competition across the world in both our snacks and beverage businesses as we have observed in the first half of the year, and that’s what we anticipate for the balance of the year.

Hey. Thanks. Good morning. I'm trying to get a little bit more specific around the Gatorade innovation. We're seeing it very much in the marketplace. And in the release, you talked about Gatorade being up double-digits in the quarter. But when we look at Nielsen, it indicates something that significantly trails that. So I was just curious about how much of the performance you're seeing has to do with incremental shelf space and distribution given the breadth of innovation and new product activity there has been.

Yeah, Lauren. I think a couple of factors are at play. The G2 DSD has a significant impact on when we reflect our sales and the consumer purchases compared to previous years; the cycle has reduced substantially. We feel good about the sports category even though it has been slow in some areas of the country for the month of June. However, within the categories, we continue to have healthy metrics in terms of penetration and usage. Our innovation—G FIT, Gatorade, and most importantly our powders and tablets—is performing very well. We believe those segments will continue to develop, along with G Zero, which attracts new consumers to the category. We're seeing improvements in all the execution metrics for Gatorade. Some of the difficulties earlier were due to supply chain issues, but we now see improvements in inventory, display, and service levels. It is true that new entrants, like Prime, have been taking some shelf space, particularly among younger audiences, but we feel confident about our brand's execution and performance. We have increased advertising substantially for Gatorade, and we aim to maintain that focus throughout the summer and the year.

Hi. Good morning, everyone. So my question is more on the balance of pricing and volumes. You're lapping some of the strongest price increases from last year. Are you expecting high-single digits in the second half with volumes flattish or possibly still negative? I'm trying to reconcile the implied organic growth of around 7.5% with better volumes. So are you seeing some improvement there as pricing normalizes for the consumer? How should we think about that comment on the discounters?

Hi, Andrea. So regarding the balance sheet revenue, the squeeze is at 7.5%. What I think we're going to see is that volumes will likely remain flattish for the balance of the year. Obviously, there's still carryover pricing, and we will follow our normal pricing cycles. You usually see pricing in the beverage business in the fourth quarter. Frito typically doesn't go in the back half of the year, but we will see how it plays out. Our forecast reflects a return to normal pricing and sets us up for 2024, which is the core of our long-term guidance, with momentum expected to carry forward.

Hi. Good morning, Hugh. Just a follow-up on the gross margin. You mentioned that pricing tailwinds year-to-date are in line or offsetting inflation. Is this a total inflation comment or is there a mix tailwind as well? I see a significant benefit from pricing compared to commodity inflation. Is that incorrect? Also, regarding the full year gross margin, unless there are offsets, it seems like you could see substantial expansion for the full year. Am I misunderstanding this?

Yeah. So what I meant is that pricing is up exactly in line with our commodity inflation, and both are in the teens, hence essentially offsetting each other. For the balance of the year margins, we have previously communicated that we would be at least equal to last year, but we're now going to be ahead of last year's margins. The driver is productivity, attributed to investments in digitalization, automation, and expanding global business services. This pivot is evident in our numbers; margins will improve sustainably due to productivity, not a one or two-quarter phenomenon.

Thanks, operator, and good morning, everyone. I was hoping to get some updated thoughts on the Celsius agreement and what you've learned over the past several months? Obviously, the growth has been tremendous, but how has that outsized growth or better-than-expected share performance shifted your view on whether this is the right structure for PepsiCo longer term? Additionally, I’d like to know if the recent Bang and Monster news may impact Celsius’s growth trajectory moving forward?

Yeah. Good morning. I think several conclusions can be drawn. Firstly, the power of our distribution system, our DSD machine in the U.S. is effective. Secondly, Celsius attracts new consumers to the energy category—individuals who previously were not consuming energy drinks for several reasons. This is a positive development as the category expands, and we appreciate having Celsius in our portfolio. We're actively exploring additional international opportunities to expand the brand, particularly in more developed markets where the energy category is established. Those are our primary realizations pertaining to our partnership.

We’re very happy with the investment we've made, and we feel comfortable where we currently are with that company. I believe we are both benefiting from each other's capabilities.

Great. Thank you very much and congratulations on another terrific quarter. I'm wondering if we could focus on air, which is doing really well in Europe. Could you remind us of the business mix in Europe between snacks and beverages? And how the business is performing so well? Is significant pricing involved? And do you think there are structural long-term changes in the pricing dynamics in Europe?

Thank you. Yes, the European business has had a really strong first half of the year, and we're expecting that to continue in the second half. A few elements contribute to this: we have a robust snack portfolio, good market positions to promote our snacks, and solid competitive positioning in beverages, particularly our zero propositions which are gaining market share in affluent European markets. There were pricing adjustments in '22, and our team skillfully found win-win solutions with customers in '23, yielding strong pricing levels. It's also remarkable how the team is driving substantial productivity through business simplification and other initiatives we’ve undertaken. We're optimistic about Europe and the business's future, given these drivers.

Great. Thanks, and good morning. To wrap up Bryan's initial top-line question: Hugh, the implied volume cadence that you mentioned, down 2% in the first half, flattish in the second half. How does this compare with your outlook at the beginning of the year? I'm trying to understand if the 4 points of upside in organic growth versus the February forecast are driven more by better volumes or superior price mix realization, or a combination of both?

Hi, Steve. Good morning. It's indeed a combination. Volumes are better than anticipated, and the price realization also exceeded expectations. So, it's a blend of both factors.

I would add that our commercial teams have successfully minimized elasticity. Our earlier assumptions were based on historicals, and we’ve been positively surprised by the strength of the brands in some markets. The results stem from the investments we've made, including our innovation and range expansion efforts, all benefiting from better data and digitalization. It all ties together, and we're pleased with the overall business performance in that regard.

Hey. Good morning, everyone. A quick question on Frito-Lay North America. Clearly, very strong results in the quarter. We’ve seen a bit of a slowdown in track channels recently. What do you think is driving this slowdown? Is it primarily due to high price realization, or is there a general sense regarding volume? Also, why are you seeing issues in untracked channels?

The Frito-Lay division is having a tremendous year, which follows a very successful 2022, driven by our large brands and effective marketing programs. Notably, our away-from-home and independent small store businesses draw significant impulse consumption, so they are not always represented well in reports. We’ve only seen a slowdown due to the lapping of last year's price increase. Otherwise, our supply chain service levels are improving, reflecting better performance and broader product availability. We're seeing strong trends across our portfolio, especially with new launches like jerky products. Overall, we’re confident in the business's ongoing performance.

Hi. Thanks for the question. My question is focused on energy drinks, particularly regarding near-term distribution opportunities. You've obviously been a great partner for Celsius. Going forward, how do you think about penetrating non-measured channels, specifically in food service such as college campuses? Will the comprehensive rollout of these products happen in the back half of this year, or is it more of a 2024 opportunity? Any additional timing insights and the potential halo effect on your legacy energy products would be helpful.

We are pursuing opportunities for our energy products throughout our brand portfolio as needed. Locations such as college campuses are significant for our energy execution. When you visit a typical campus, you would find Rockstar, Celsius, and our coffee products distributed—energy products are prioritized there. We are not postponing opportunities; we are currently executing as we speak.

Great. This is the end of the conversation. Thank you very much, and thank you for your confidence in us with your investments. We hope you all have a great summer and stay safe and healthy.