PepsiCo had a good quarter, but here’s the bad news to watch

Global food and beverage powerhouse PepsiCo (PEP -0.17%) reported the third-quarter earnings too much fanfare. With strong growth and an upgrade to full-year 2022 guidance, it deserves the praise. However, if you dig a little into the quarterly results, there are some weaknesses worth watching closely.

A very positive performance

PepsiCo, which owns the iconic Pepsi and Frito-Lay brands, reported third-quarter revenue growth of 8.8% year over year. Organic sales growth was a whopping 16%. Adjusted earnings per share rose 14%. This was despite a 3 percentage point headwind from currency issues related to the strong dollar. Overall, the food maker had a good quarter.

A person shopping in the takeaway aisle of a grocery store.

Image source: Getty Images.

It gets even better because management raised its guidance for full-year 2022. Organic sales are now expected to grow 12%, a full 20% above its previous target of 10%. Adjusted earnings per share are now expected to rise 10%, compared to a previous forecast of an 8% improvement. Once again there is a lot of good news.

An important part of the story is the company’s ability to raise prices in the face of inflation. That’s what every consumer staples company is trying to achieve today, along with cutting costs to protect operating margins. But this is a tricky dance involving PepsiCo’s direct customers (retailers) and its end customers (consumers). Once consumers start pushing back, the process becomes much more difficult.

early warning signs

For that reason, it’s notable that PepsiCo’s operations, which are split into food and beverages, are showing some signs of early trouble. On the drinks side, the company was able to increase volume by 3%. Only the European business saw a decline in volume, but that wasn’t enough to derail the entire division.

On the grocery side of PepsiCo’s business, however, volume was down 1.5%. That’s not massive, but four of the six regions/businesses it reports on in the food division saw volume declines, including Frito-Lay North America and Quaker Foods North America. These are important deals. And of course, the two regions where volume increased weren’t enough to offset negative impacts elsewhere.

Drinks and food are different. Not so much, however, that you would expect one to be completely immune to the ill effects of price increases while the other begins to switch consumers to cheaper items. This is exactly how consumers express their dissatisfaction with rising product costs. It’s far more likely that a decline on one side of PepsiCo’s business should be taken as a warning that the other side could soon be weakening.

That’s not to say PepsiCo’s business is about to crash. It has long been a reliable company that uses its strong brands to grow over time. In fact, as a Dividend King with five decades of annual dividend increases, the company has clearly had periods of inflation before. And it’s very likely to work dexterously in the current, albeit dramatic, inflationary bout it’s facing today. But that doesn’t mean the ride will be as smooth in the coming quarters as it has been in the recent past.

Prepare for a tougher 2023

If you’re a long-term PepsiCo shareholder, there’s no need to panic. It’s still a well-run company worth owning. However, the difference between the company’s grocery and beverages shouldn’t go unnoticed. The dichotomy suggests that PepsiCo could find the future increasingly challenging as the calendar flips to 2023.

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