On Oct. 5, PepsiCo held a Q3 earnings call that furnished fresh insights into what’s arguably the top issue in the nearly $2 trillion consumer packaged goods (CPG) industry: Now that input costs are famously jumping, will consumers buy fewer soft drinks, snacks, or beer or go with cheaper brands? Or are families brimming with so much cash and optimism in the reopening that at least for now, they’ll keep profits humming for a Nestlé, Mondelez, Brown-Forman, Coca-Cola, and Pepsi?
In the Q&A with analysts, Pepsi CEO Ramon Laguarta noted a remarkable shift in consumers’ buying habits that’s buoying the soda and snack giant’s results, spotlighting a trend that’s also benefiting CPG stalwarts from Constellation Brands to General Mills. Put simply, Laguarta finds that folks are now a lot more willing to shoulder higher prices for Pepsi’s products and stack their shopping carts just as full with its offerings—an array that encompasses such top sellers as Fritos and Lay’s, 7-Up and Mountain Dew—as before the recent uptick. To make his point, Laguarta cited a concept out of an economics textbook. “What we’re seeing…is much lower elasticity on pricing than we’ve seen historically,” he declared. “Price elasticity” refers to the change in demand caused by a change in price, and Laguarta is saying what customers are purchasing isn’t changing much even as Pepsi keeps charging more.
Of course, Laguarta proudly attributes much of that lack of “elasticity” to the strength of his brands and that families are getting “more and more emotionally attached” to Pepsi’s offerings. Still, the CEO sees a consumer who’s bringing an eager, non-penny-pinching bounce to supermarket aisles and corner restaurants. “Consumers are shopping faster and paying less attention to pricing as a decision factor,” he said. “Consumers seem to be looking at prices a little bit differently than before.”
Strong pricing is boosting Pepsi’s results
Folks’ willingness to keep opening their wallets while the dining tabs and tallies at the checkout counters keep rising is greatly aiding Pepsi, as well as sundry CPG titans. Pepsi’s revenues are racing. For the opening three quarters of 2021 (ended Sept. 4), its sales grew 13.2% over last year to $54.2 billion and beat its pre-pandemic, nine-month number for 2019 by almost 17%. Pepsi’s in-store and online sales thrived during the pandemic even as revenues from outside dining cratered. Now, purchases at grocery stores or delis are still going strong. At the same time, the snacks and beverage “out-of-home” businesses have rebounded 30% from last year’s depressed numbers. “It’s gotten back to just about 2019 levels,” Laguarta said on the call, adding that on the dining-out side, “you can say we’re sorta back to normal.”
In its earnings release, Pepsi raised its guidance on revenue growth for 2021 substantially, from 6% to 8%. For Pepsi and the CPG players, sales are surging because the consumer is emerging from the lockdown in robust shape. “A major reason they’re so healthy is the government stimulus payments,” says Vivien Azer, an analyst at Cowen. She cites the child tax credit payments that began on July 15. The extra cash will go to 39 million families; they’ll receive $300 a month for each child under age 6, and $250 for kids ages 6 to 17. Middle- and upper-middle-class families mainly kept their paychecks throughout the crisis and banked big savings in the lockdown. Low- and middle-income workers are prospering, too. Their wages are rising briskly for the first time in years. That’s a trend that could give the current spending run legs even as the stimulus fades.
So mom and dad are frequently flush with cash right now and don’t seem to mind ditching the kitchen table for the neighborhood McDonald’s, which features Coke beverages, or Taco Bell, KFC, or Hooters, which serve Pepsi drinks. As the Pepsi experience shows, the exhilaration of renewing old dining pleasures trumps spending a bit more on a 7-Up or Pepsi Black Cherry Cola.
Cost pressure are intense
The pricing power that Laguarta highlights is enabling Pepsi and other top names in food and beverage to offset a significant part of the biggest jump in expenses that the industry has witnessed in decades. “We’re seeing much higher cost inflation,” says Azer. “The inflation cycle is noteworthy versus history.” The pressure’s coming from all sides. Supply-chain disruptions are upending the flow from farms to factories to store shelves. Agricultural commodities, freight, labor, and packaging are all posting sharp spikes. In the past year, aluminum prices per ton have jumped 66%, swelling the line item for beverage cans. A bushel of corn that ran $3.80 in February 2020 now fetches $5.25, a leap of 38%. According to Cass Information Systems, rates for flatbed trucks are up by one-third versus a year ago, a rise driven in part by a similar increase in the cost of fuel. A dire shortage of drivers is another big factor, further raising the over-the-road cost burden. That’s just one of the many labor bottlenecks lifting wage bills. CPG-makers are also raising pay to attract and keep factory workers.
If Pepsi couldn’t respond by boosting prices, its rampaging costs could erase the benefits of selling all those extra sodas and snacks in the great reopening. In fact, Pepsi, like the other CPG giants, can’t lift what it charges quickly enough to offset racing costs. That dynamic is squeezing margins. Still, the combination of price increases that counter a large part of the mounting expenses, and fast-rising revenues courtesy of a buoyant consumer, is keeping total profit dollars swelling at a healthy clip. Those profit dollars are the number that matters most—that pay the bills and reward shareholders. Plus, if costs moderate and pricing power persists, the CPG crowd may well manage to keep sales waxing in line with expenses, or even start growing margins. “We expect to be able to push through the inflation that we’re facing, whether it be commodities inflation or other types of operating expense inflation,” CFO Hugh Johnston stated on the Q3 call. “Some of that pricing occurred in the summer,” he said. “Much more of it is occurring in the fall in the beverage business.” As for snacks, Johnston notes that “substantially” all of the increases for 2021 are coming “as we speak during these weeks right now.” He added in a CNBC interview that day, “We’ll probably see a bit more price increases in the first quarter of next year as we deal with the fact that input costs are just higher. That’s the reality for us and everyone else.”
To gauge how much the consumer’s willingness to pay more is helping Pepsi, let’s compare how fast prices were rising pre-pandemic to the recent trend. I looked at the average increases for both snacks and beverages in North America for the seven quarters from January 2018 to September 2019, and from the start of 2020 to the close of Q3 this year. In the pre-COVID period, Pepsi lifted prices an annualized clip of 2.2% for drinks and 3.3% for snacks. In the past seven quarters, beverages waxed much faster at 3.9%, and snacks led the former span by just a tad at 3.4%. But keep in mind that PepsiCo is just now starting to charge more for the salty favorites.
To be sure, the cost explosion has hurt Pepsi’s margins. But they’re still faring pretty well versus pre-pandemic levels, and once again, its overall profit dollars are waxing fast. For the first nine months of 2021, Pepsi reaped operating earnings on North American beverage sales of 11%, same as in January to early September 2019. Its margin on snacks—they’re really profitable—dipped from 31% to 29.6%, but once again, shoppers will be paying more for the munchables in the months ahead. The combination of advancing sales and the strength to prevent a big erosion in margins lifted operating profits over those two years by 13.2% to $8.6 billion.
That’s a terrific result. But Pepsi and the other pillars of CPG can’t count on rapidly raising prices for too much longer. Eventually, consumers will go with cheaper store brands, or visit McDonald’s or KFC once a month instead of once a week. More likely, the huge run-ups for the likes of packaging and commodities will attract new waves of supply, reversing or flattening the upward trajectory in costs. With lower expenses will come lower prices. But for now, this lower “elasticity” is boosting bottom lines—and no doubt waistlines—across America.
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