Tickers in this Article: PEP, KO, K, KFT, GIS, UL, NSRGY
Global beverage and snack food giant PepsiCo (NYSE:PEP) offers a good lesson as to why many investors believe that valuation always matters. PepsiCo was, and is, a fine company, but the valuation has been a little too fizzy for some time. The net result? A stock that has significantly lagged the market and its large rival Coca-Cola (NYSE:KO) over the past couple of years. Now with global commodity pressure and a strained consumer, Pepsico seems to be running a little flat.

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Second Quarter Results Lacking Some Quality
It is hard to get especially enthusiastic about second quarter results at PepsiCo. While reported revenue did indeed climb nearly 14%, organic revenue growth was a little less than 5% (the company uses its own different metric for organic growth and reported 8% growth by its methodology). Growth was definitively led by the international operations, as PepsiCo Americas Foods posted 7% organic growth, while Americas Beverages was basically flat. Volume was likewise iffy - total snack food volume was up about 10%, while beverages rose about 1%.

Profitability was where PepsiCo really seemed to disappoint. Gross margin contracted slightly, while segment operating profits rose about 12%. Here again, snack foods did well (some modest margin expansion), while beverages were not so strong. Were it not for lower taxes and some other miscellaneous items, the bottom line number would not have met consensus.

Global, but Global Enough?
It is somewhat strange to see PepsiCo lagging Coca-Cola to this extent when it comes to issues like commodity costs - while both are global giants, apparently Coca-Cola has positioned itself better via its exposure to global currencies when it comes to offsetting dollar-based commodity costs.

That said, there is still plenty to like about PepsiCo's structure. The company is seeing very good growth in emerging markets like China, Turkey, Brazil and India, and were Frito-Lay a standalone company, it would compare very favorably to other U.S.-based food companies (like Kellogg (NYSE:K), Kraft (NYSE:KFT) and General Mills (NYSE:GIS)). In fact, PepsiCo is one of the relatively rare U.S. packaged food companies to have a global footprint similar to that of Unilever (NYSE:UL) or Nestle (Nasdaq:NSRGY).

Battening Down the Hatches?
Of all the things that seemed to spook investors about PepsiCo's earnings, it was probably the rather cautious commentary by management regarding the North American consumer. While plenty of food companies have talked of putting prices, that is proving to be an unpopular move and companies like General Mills are paying for higher prices with significantly lower volumes. That leaves PepsiCo with a set of unappealing options - either swallow the higher input costs or sacrifice sales volume and market share.

If there is a silver lining, it is that market conditions ebb and flow but packaged food and beverage brands generally endure. Business will pick up in North America at some point and the company can continue to exploit the rising standard of living (and growing appetite for processed/packaged food) in emerging markets. While there is perhaps some long-term risk that governments will crack down on makers of unhealthy foods (notions like a "soda tax" have been floated), ultimately people are going to eat what they want to eat.

The Bottom Line
Even after a stretch of lackluster performance, PepsiCo is not exactly cheap. It is cheaper than Coca-Cola, but given the respective differences in outlook and earnings quality, it deserves to be. If PepsiCo shares get about 10% cheaper (or the shares stay flat and a few more quarters of growth roll by), the stock gets significantly more interesting. For now, though, there are better options on the shelves for investors. (For related reading, also take a look at Analyzing Retail Stocks.)

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