PepsiCo profit hit by China deal; beats estimates

1 / 2
This Tuesday, July 17, 2012, photo, shows bottles of Pepsi in Montpelier, Vt. PepsiCo Inc.'s second-quarter profit fell 21 percent, as a deal to expand its business in China, restructuring costs and a stronger dollar ate into results. The company, whose brands include Frito-Lay, Gatorade and Tropicana, said Wednesday, July 25, 2012, that it booked charges in the quarter related to the refranchising of its beverage business in China to Tingyi Holding Corp. The move is considered key because it dramatically expands PepsiCo's reach in a fast-growing region. (AP Photo/Toby Talbot)

NEW YORK (AP) — PepsiCo's second-quarter results had some fizzle, but very little pop.

The maker of everything from Frito-Lay chips to Tropicana juices said Wednesday that its net income fell 21 percent but beat Wall Street estimates as it spent more on advertising to cement its brands in consumers' minds so that it can continue to raise prices.

But so far, its price hikes, which are intended to offset PepsiCo's higher costs for ingredients, are yielding mixed results. Worldwide, the increases boosted sales of its existing brands that were not part of acquisitions, divestitures and foreign-exchange translation, by 5 percent. But they put pressure on its key North American soda business, which had a 4 percent drop in volume.

PepsiCo Inc.'s quarterly results provide a window into the reality for many food and beverage companies right now. They are being squeezed by higher costs for corn and other ingredients they use to package and ship their products. But rather than relying on sales and discounts to boost volume like many companies have, PepsiCo is betting that increasing advertising and rolling out new products will make its brands more resilient to competition and give it more flexibility to raise prices without scaring off customers.

As part of a turnaround plan it announced in February, PepsiCo is ramping up marketing of key brands like its flagship Pepsi soda and Gatorade sports drink. In fact, the company increased its media spending in the U.S. by more than 40 percent during the latest quarter compared with a year ago. That sent operating profit for the key Americas beverage business unit down 15 percent.

PepsiCo Inc., based in Purchase, N.Y., also rolled out new products to boost results. The company is hoping one of them, Pepsi Next — which has about half the calories of regular soda — will increasingly contribute to revenue growth.

Whether PepsiCo's strategy pays off remains to be seen, said Citi analyst Wendy Nicholson. But she notes that PepsiCo's aggressive marketing in the early part of this year hasn't yet delivered stronger volumes.

"We think there is still room for debate about whether Pepsi's investment spending truly leads to stronger market shares over time," she said.

So far, the results have been mixed.

PepsiCo earned $1.48 billion, or 94 cents per share, in the three months that ended June 16. That's down from $1.89 billion, or $1.17 per share, in the same period last year.

The company's results were hurt by a deal to expand its distribution in China. They were also negatively impact by a strong U.S. dollar. Companies like PepsiCo that do a lot of business overseas take a hit when the dollar strengthens because their sales in other countries translate into fewer dollars back home.

Not including the impact from those items, PepsiCo said it earned $1.12 per share, above the $1.09 per share analysts polled by FactSet were expecting.

Revenue slipped to $16.5 billion from $16.8 billion. The company said that was primarily the result of refranchising its beverage businesses in China and Mexico. That means that revenue in those countries is now recorded by the company's local partners.

In its Frito-Lay unit, sales volume in North America was flat, while price hikes helped lift revenue by 3 percent. For the Quaker Foods unit, volume decreased by 1 percent and operating profit fell 8 percent due to higher commodity costs.

The company's performance was better in other parts of the world. Global sales volume of snacks rose 6 percent and sales volume for global beverages rose 1 percent.

Excluding the impact of unfavorable exchange rates, operating profit in Europe rose 15 percent due to price hikes and cost-saving measures. Food volumes rose 1 percent, driven by gains in Russia and Eastern Europe. Beverage volume fell 2 percent.

In the Latin America foods unit, revenue rose 8 percent as a result of higher prices and the benefit of acquisitions. And in region encompassing Asia, the Middle East and Africa, snacks volume rose 16 percent and operating profit excluding the impact of currency exchange rates rose 7 percent.

Going forward, PepsiCo is optimistic. The company stood by its forecast that its adjusted full-year profit will decline by 5 percent.

Chief Financial Officer Hugh Johnston said that record corn prices — a result of the severe Midwestern drought — shouldn't impact the company's forecast for commodity prices this year because the company locks in its pricing for ingredients in advance. He declined to speculate on the impact in 2013 but noted that corn is just one of the many ingredients PepsiCo uses for its food and drinks.

To offset costs, PepsiCo is undertaking cost-cutting program this year that it says will help refresh its business and ultimately save it money in the years ahead. The plan, which includes a 3 percent workforce reduction, comes with upfront restructuring costs that are expected to continue through the year.