Poster Child for Phantom Growth
Why All Eyes Should Be on Pepsi
“This is a serious pushback on price over volume movement.”
So came the text Thursday from my pal Ben Brey of Deductive Capital, his family office.
In this case, he was pointing out a Reuters story that French retailer Carrefour had stopped selling PepsiCo’s products in four European countries because they have become too expensive. He added...
This is serious pushback on the price over volume movement.
Impact on Earnings
The role pricing has played in driving growth is something to keep in mind. And not just for Pepsi, but throughout corporate America as we head into this earnings season and the next few going forward.
This has been a “not if but when” risk that has been hiding in plain sight as prices have been rising. Or akin to what I wrote last April in, “The Magic of Phantom Growth”...
People forget how ugly things can get, not to mention how fast it can happen.
That writeup was prompted by a report from my friends Bill Whiteside and Jeff Middleswart in their newsletter, A Peek Behind the Numbers. (They also run the independent long/short institutional research firm, Behind the Numbers.)
Price Increases vs. Volume
Their report had been headlined, “The Organic Growth Illusion,” and its message was exceedingly clear: Something’s gotta give. Or as they explained...
Investors must always remember that organic growth is a function of volume growth plus price increase.
They were back last Friday after the Carrefour/Pepsi news with a comment on Substack’s Notes warning about the impact of pressure on pricing...
The problem is taking away even a little pricing could cause these companies to miss forecasts.
They went on to explain that if Pepsi, Coca Cola and Keurig Dr. Pepper each lost 1% of their pricing in the fourth quarter rather than beating estimates by 10 cents, 5 cents and 1 cent, respectively...
Pepsi’s earnings would have been 13 cents lower.
Coke’s would have been 2 cents lower.
Ditto for Keurig Dr. Pepper.
To better visualize it, they included this table, which clearly tells the price/volume story...
Expectations vs. Reality
But it’s worse, because as this chart from Morgan Stanley via Ben shows, the street expects pricing to lead the way for years...
In other words, the models that are driving current valuations don’t take account the end of price increases, yet they accounted for all of 2022’s growth.
The impact shouldn’t be surprising. Pepsi’s company-wide volumes through the third quarter slipped 2%. Anecdotally, Ben says his mother, who lives in the Midwest, now only buys Pepsi snacks and drinks “when they re on sale.” As he explains...
This is interesting, because if they can't keep taking price and wage/cost pressure remains – and interest expense likely rises by high single digits for the next few years – you have a situation where it will be impossible for these guys to grow earnings.
With a 2.5% dividend yield and 2x leverage and negative volumes and rate exposure – this seems like the type of thing to short to me.
Or from another perspective, the kind of stock to avoid – at least until this dynamic gets sorted out…
Pepsi isn’t alone. Consider, for example, what Unilever CFO Graeme Pitkethly said on his company’s earnings call last October…
The extent of price increases, whilst historically high, has still not been enough to cover the cost inflation that we've experienced, and as a result, Europe's margins remain well below the Unilever average.
He’s telling you what might happen, in not so many words.
But from an investment perspective, as Ben puts it, “there’s a lot of complacency in these mega-caps.”
At least for now…
Reversion to the Mean?
Here’s the thing: While Pepsi may be a poster child of what to watch, it’s in good company, with non-financial U.S. corporate margins at historical highs. The below chart from DSP Asset Managers lays it out...
Ben again...
What if margins simply need to revert to 8-9%? Pro labor policies mean the 40 year pro capital policies likely over. But much worse for stocks obviously Like Apple is running 33% EBITDA margin. Why can’t that be 25%?
There’s no reason it can’t. Obviously nobody knows how all of this will all shake out, but this earnings season should give a good preview.
If nothing else, however, just remember – every basis point counts on the way up... and down.
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DISCLAIMER: This is solely my opinion based on my observations and interpretations of events, based on published facts and filings, and should not be construed as personal investment advice. (Because it isn’t!)
Feel free to contact me at herb@herbgreenberg. You can follow me on Threads @herbgreenberg.
Interesting article! I probably wouldn't put so much emphasis on the method of sales forecasting. To me, it looks more like they are making general assumptions about volume growth (e.g., through population growth) and price growth (e.g., inflation). And the fact that pricing power is not infinite and that retailers/supermarkets sometimes resist it, happens more often.
Thanks Brian! Good question... will be watching it all unfold!