Quarter Was Bubbly for PepsiCo; Soft Drink, Snack Food Maker Sees Earnings Increase By 13 Percent

NEW YORK — Soft drink and snack food maker PepsiCo Inc. on Tuesday reported a 13 percent rise in second-quarter earnings, driven by strength in China and other developing markets as well as strong domestic sales of cereal and pasta in its Quaker Foods business.

The company, which also owns Frito-Lay snacks, said it would bolster investment in its North American beverage business and overseas in order to revive sluggish soda sales. The increased spending on new products comes as PepsiCo and archrival Coca-Cola Co. each grapple with declining soda sales, as global consumers are increasingly drawn to coffee, tea and juice items.

“We do intend to step up investments in North American beverages and in our international business,” Chief Financial Officer Indra Nooyi said in a conference call. Among other things, the company also said it would “invest aggressively” in new drinks like Pepsi One, a new diet soda, and Pepsi Lime.

PepsiCo, the world’s No. 2 soft drink maker, reported second- quarter profit of $1.19 billion, or 70 cents per share, for the 12 weeks ended June 11, up from $1.06 billion, or 61 cents, in the year- ago period. The company also forecast full-year earnings in line with previous guidance.

The results beat Wall Street’s consensus forecast of 67 cents per share, and PepsiCo’s shares rose $1.04, or 1.9 percent, to $54.89 in late trading on the New York Stock Exchange, where the stock was among the most actively traded issues.

“Earnings came in better than what the market expected. What’s encouraging is that they can still generate strong top-line growth in both food and beverage in North America, two key businesses,” said Bonnie Herzog, managing director and food analyst at Smith Barney. “Their international business continues to be strong. That’s where you’re seeing a lot of growth and margin expansion.”

Revenue rose 9 percent to $7.7 billion, topping analysts’ average forecast of $7.56 billion. Volume rose 2 percent at Frito-Lay North America, whose brands include Lay’s, Cheetos, Tostitos and other salty snacks, and climbed 12 percent at Quaker Foods North America, led by strong volume gains in Quaker oatmeal, Rice-A-Roni and Pasta Roni side dishes, and Aunt Jemima syrup and mixes.

In the standout international division, snacks volume rose 3 percent, while drinks volume jumped 10 percent. PepsiCo said it saw strong snacks growth in developing markets like India, China, Russia and Turkey, while drinks volume growth was led by the Middle East, China and Argentina.

However, volume growth at PepsiCo Beverages North America declined by half a percent due to sluggish carbonated drink sales, reflecting Americans’ shift from drinking soda in favor of bottled water and other drinks seen as healthier. Volume growth of noncarbonated drinks like Aquafina, Propel fitness water and Gatorade mostly offset the decline in carbonated soda.

Smith Barney’s Herzog said both PepsiCo and Coca-Cola have been diversifying beyond their mainstay soda brands as consumers worldwide drink less soda, but PepsiCo has had an advantage over Coke as a result of its 2001 acquisition of Quaker Foods which included the popular Gatorade brand.

“One of PepsiCo’s biggest strengths is strong execution. They’ve always been able to execute well in both beverages and snacks,” Herzog said.

Investment to increase

PepsiCo did not say how much it planned to invest this year, but noted the increased spending in new products would dampen profit growth for the rest of this year.

“Quaker Foods North America’s profit performance in the second half will be lower than the first half, as we expect to see the top line slow down a bit and as we make investments in advance of 2006,” CFO Nooyi told analysts in the call.

The increased investment will also weigh down earnings growth in the company’s North American beverages business, Chief Executive Steven Reinemund said.

PepsiCo also said it doesn’t see a “significant” impact from the stronger U.S. dollar, whose recent appreciation is forecast to hurt results for U.S. companies that do a lot of business overseas. International business accounts for roughly 36 percent of PepsiCo’s total revenue, while Coke — which gets about 69 percent of its revenue outside North America — is more sensitive to currency fluctuations.

The company also said it expected inflation to ease for the rest of the year, except in terms of oil. However, PepsiCo has hedged most of its energy costs at Frito-Lay, which it says is most vulnerable to oil prices.

This year, PepsiCo said it expects to earn between $2.56 to $2.59 per share, excluding the impact of a 53rd week. Including the extra week, the company forecasts profit of $2.60 to $2.63 per share.

In its April earnings release, PepsiCo forecast 2005 earnings per share of at least $2.56 excluding the extra week, and earnings of at least $2.60 per share including the final week. Wall Street’s average full-year forecast is $2.58 per share, according to Thomson Financial.

PepsiCo also said it is considering repatriating overseas earnings this year under the American Jobs Creation Act, a major corporate tax law created last year. The company said it believes it can repatriate as much as $7.5 billion, but did not include that amount in full-year guidance.

Local Angle

Frito-Lay, owned by PepsiCo, employs more than 600 at its snack food manufacturing plant in Vancouver.