PepsiCo’s Q3 Earnings: Will Defensive Strength Prevail Amid Weak Sales?

PepsiCo’s (PEP) Q3 earnings on October 8 could offer a chance to showcase its recovery, especially as the stock has underperformed the S&P 500 this year. I remain bullish long-term due to the consumer staples giant’s defensive nature, strong cash flows, and an attractive dividend yield. While the international segment may help stabilize revenues, weakness in PepsiCo’s North American sales could prompt a downward revision in the organic sales growth outlook in the short term. This makes me stay on the sidelines ahead of the earnings report.

Although the market has favored recession-proof stocks like PepsiCo in recent months following its Q2 earnings, the recent Federal Reserve interest rate cut has eased concerns about growth stocks and reduced the appeal of defensive names. Consequently, I question whether this defensive strength will be enough to sustain the market’s optimistic sentiment toward PepsiCo.

Recap of PepsiCo’s Q2 Performance

My long-term positive outlook on PepsiCo remains intact, even after its mixed Q2 results on July 11, though it raised a few short-term concerns. The company reported quarterly EPS of $2.28, beating estimates by $0.12, but revenue of $22.5 billion, while up 0.8% from the prior year, fell $100 million short of expectations.

This performance reflected consumer staples’ reliance on pricing power in a challenging macroeconomic environment. Additionally, demand for snacks and beverages has been impacted by the rising use of GLP-1 weight loss drugs, with organic volume for Frito-Lay North America dropping by 4%.

On the bright side, the bottom-line beat was driven by strong productivity and cost control. Cost of sales fell from $10.1 billion to $9.9 billion year-over-year, leading to a 10.6% year-over-year increase in operating profit. PepsiCo’s effective expense management likely mitigated a more negative market reaction.

Crucially, PepsiCo maintained its defensive appeal by continuing to reward shareholders with buybacks and dividends. It expects $1 billion in buybacks and $7.2 billion in dividends for the year – an increase of approximately 8% from last year’s total dividend payments. Currently, PepsiCo offers a dividend yield of over 3% and boasts an impressive streak of more than 50 years of dividend increases.

Q3 Preview for PepsiCo and What to Expect

While I remain bullish on PepsiCo long term, the upcoming quarter could pose challenges. Much of the positive post-Q2 reaction was not only due to PepsiCo’s results but also investor preference for defensive, cash-generative, dividend-paying stocks amid U.S. recession fears. On these fronts, PepsiCo has shown it’s on the right path. However, last quarter, management adjusted its annual organic revenue growth outlook, forecasting top-line growth of about 4%, down from the previous guidance of “at least 4%.”

Meanwhile, a key advantage for PepsiCo in Q3 is its track record of consistently beating EPS estimates, with above-consensus results since Q4 2019. However, the company’s ability to top revenue projections has been less consistent, missing top-line estimates in Q2 2024 and Q4 2023. That said, as a low-volatility stock with a beta of 0.2, even when PepsiCo misses expectations, its stock typically sees limited post-earnings downside.

While a comprehensive earnings beat is essential for a stronger market reaction, PepsiCo’s moderate international growth should help offset slower U.S. sales, as observed last quarter, and help to surpass top-line estimates. Furthermore, increased contributions from PepsiCo’s productivity initiatives are anticipated to support EPS projections.

For Q3, the outlook is more cautious. In the past three months, all 14 analysts who revised their EPS projections have lowered them, with the consensus now expecting $2.30 in Q3 EPS, reflecting a 2.2% year-over-year increase. On the revenue side, eight of nine analysts have also reduced their estimates, with projections now indicating a modest 1.6% growth to $23.8 billion.

What the PEP Option Chains Are Indicating

As a low-beta stock, PepsiCo’s option chains indicate mild volatility ahead of its earnings report. The option chain data shows an expected price swing of 3.4% in either direction, based on the at-the-money straddle for options expiring after the earnings announcement. This expectation is calculated using the $170 strike price, with call options priced at $3.75 and put options priced at $2.19, for the expiration date of October 11.

Is PEP Stock a Buy, According to Wall Street Analysts?

On TipRanks, Wall Street remains somewhat divided on PepsiCo. Despite a consensus rating of Moderate Buy, out of 17 analysts, eight recommend Buy while nine suggest Hold. The average price target is $186.06, implying an upside potential of about 9% on the latest share price.

Goldman Sachs (GS) analyst Bonnie Herzog has a cautious sentiment on PEP stock ahead of the results. While maintaining her bullish stance, she lowered her price target from $195 to $192, citing persistent consumer headwinds in Q3 and a possible reduction in management’s organic growth projections. However, Herzog sees PepsiCo as strategically well-positioned for the future, which justifies the Buy rating. 

The Bottom Line: Neutral on PEP Ahead of Q3 Earnings

In summary, while I maintain a long-term bullish outlook on PepsiCo due to its defensive characteristics and solid cash flow, the short-term challenges from declining North American sales and a cautious market environment warrant a neutral stance ahead of Q3 earnings.

I believe PepsiCo’s ability to offset declines in North America with growth from its international segment, along with maintaining guidance for the remainder of the year, will be key to a positive market reaction following Q3 results, especially if it surpasses Wall Street’s expectations.

Given the mixed sentiment and lowered expectations from analysts, investors should remain cautious, and I would refrain from buying PEP at this time ahead of its earnings.

Disclosure