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PepsiCo's Hot Spell

By David Kiley Driven by strength in overseas markets and strong sales of cereal and pasta at its Quaker Foods operation, PepsiCo (PEP) reported a 13% rise in second-quarter earnings on July 12. The better-than-expected results, especially in the crucial global market, once again proved the wisdom of PespiCo's diversified food portfolio as a hedge against a falling demand for colas.

For the quarter ended June 11, Pepsi reported earnings of $1.19 billion, or 70 cents per share, vs. $1.06 billion, or 61 cents, in the year-ago period. These results beat Wall Street's average forecast of 67 cents, as reported by Thomson Financial. Revenue rose 9%, to $7.7 billion, above analysts' average forecast of $7.56 billion. Operating profit in Pepsi's international division grew 23%, to $452 million.

BUBBLING UP. Sales volumes grew 2% at the Frito-Lay unit, bolstered by brisk sales of light and "healthier" versions of snacks under the Lay's, Tostitos, and Cheetos brands.

Meanwhile, as expected, carbonated-drink sales volume declined 4%, and Gatorade sales were up only in the low single digits. However, the outfit said it is on its way to the best-ever quarter for Gatorade in the period that that will end Sept. 11, owing to hot weather in the U.S.

Overall sales of noncarbonated drinks, led by Aquafina bottled water and Gatorade, rose 5%. Sales grew 12% at Quaker Foods North America, led by strong volume gains in Quaker oatmeal, Rice-A-Roni and Pasta Roni side dishes, and Aunt Jemima syrup and mixes.

INTERNATIONAL TASTES. Unlike rival Coca-Cola (KO), which has maintained a focus on beverages, PepsiCo may continue expanding beyond soft drinks. PepsiCo is thought to be on the prowl for alternative beverage and food acquisitions, like its purchases earlier this year of German juicemaker Punica Getranke. Last week, it denied speculation it was buying shares in French food and drinks company Groupe Danone in preparation for a takeover bid.

Coca-Cola reports quarterly earnings next week, with analysts forecasting profits of 64 cents per share. Coke has been restructuring to boost sluggish sales while simultaneously attempting to combat mounting consumer disinterest in carbonated soft drinks, on which it is more dependent than Coke's current moves remain focused on carbonated drinks. It just launched yet another Coke variant -- Coke Zero -- as well as new flavor extensions for Diet Coke, made with Splenda.

Also, Coca-Cola is relaunching Fresca with two new flavors and a revamped marketing campaign. It's also testing a new brand, Vault, which is a hybrid soft drink/energy drink, targeted at men between the ages of 20 and 30.

PROMOTIONAL BOOST. Coke's only move that has drawn cheers from Wall Street, besides top-level management changes over the last nine months, is its commitment to spending up to an additional $400 million on advertising and promotion over the next 12 months, vs. the previous year. Analysts have criticized Coke for underfeeding its brands over the last few years.

Steve Reinemund, Pepsi's chairman and CEO, said during the July 12 conference call that Pepsi also plans to spend more on advertising and promotion, including coupon offers, in the current quarter to counter Coke's moves. He expects Pepsi's beverage volume and share performance to improve in the second half. "We believe the carbonated soft-drink category has the potential to grow in positive territory," Reinemund said.

Pepsi shares closed July 12, at $54.60, up 1.4%. It raised its full-year profit forecast to between $2.60 and $2.63 a share, a hike that also reflects an extra week in the current fiscal year. In the previous fiscal year, Pepsi reported net earnings of $4.21 billion, or $2.44 a share. Even though it's relying less on carbonated beverages, PepsiCo has plenty of pop these days.

Kiley is BusinessWeek's Marketing editor in New York

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