Pepsi turns inflation pain into company gain as higher prices cause its profits to froth over

Who suffers in a time of inflation? Does business eat some pain or pass it on to consumers? Theory tells us the pain should be shared. But is theory right?

As US earnings season starts we will find out. The first clue comes from PepsiCo, one of the first American companies to report how it fared during the period July-August-September 2022. It owns brands like Doritos, Sakata rice crackers, Smiths chips, Nobbys nuts, Gatorade, and of course the eponymous cola drink, Pepsi.  

You would expect Pepsi to be suffering from high shipping costs, high input costs, and more. So it confirms:

“We continued to experience inflationary pressures on transportation and commodity costs, which we expect to continue for the remainder of 2022,” the company told the market.

If Pepsi is seeing margins squeezed, that is a sign that big business is facing a competitive environment and the pain of inflation is shared. If it is raking in profit, that may signal consumers are price-insensitive and are absorbing most of the pain of inflation. 

This latter scenario may seem great, but it carries an ominous implication. The goal of recent monetary policy has been to cool the economy and dampen consumer ardour. If consumers are still in a price-blind buying frenzy, the rate hike cycle may not be over.

So has Pepsi been fizzing?

I will let the company itself tell the story. Here’s the key line from its financial report:

“Core operating profit increased 11% and core operating margin expanded 30 basis points.”

And the killer quote from the CEO:

“Our brands are being stretched to higher price points, and consumers are following us.”

This is the dream of any business: put up prices and grow profit.

Part of Pepsi’s story is a continuing recovery from the compression of sales during the pandemic — soft drink is something people consume out of the house, so sales of drinks fell in 2020-21. Snack sales fell less back then. In the most recent quarter, revenues grew strongly in beverages: up 12%. Snack revenues grew even more: +20%. The evidence points to a broadly strong consumer market.

Pepsi’s stock price leapt on Wednesday after the release of these results, to be up 8% over the last year. But the market itself fell, perhaps sensing more interest rate hikes to come. After all, if firms are making sensational profits, the US Federal Reserve will come striding in like an outlaw into a wild west saloon, firing a big rate hike revolver until the honky-tonk and revelry stop.

Pepsi’s business is, in general, going very well. It is growing its market share in both snacks and drinks in Australia and many other international markets. However right now, thanks to the strong US dollar, that international strength is not worth what it was in their US-dollar-denominated revenue.

Over the last decade Pepsi has more than doubled its stock price, while its ancient enemy, Coca-Cola, has risen by only 44%. The big difference is salty snacks — soft drinks themselves are in retreat as people revolt against sugar, but snack sales are strong and Pepsi — after its merger with Frito-Lay — is well-placed in that market. Coke’s big sales growth has come not from its core cola offering, but from what they call “functional beverages” — energy drinks, vitamin-infused drinks and sports drinks.

More results to come

Pepsi is a terrific indicator of the strength of the global consumer economy – it is a $233 billion market cap company. However many more results are flowing, including Domino’s Pizza on Thursday US time which reported a very different set of results: falling margins amid heavy discounting. Next week we hear from United Airlines, Netflix and Tesla.

Will some of those businesses be sharing pain with consumers, or are they all making big bucks? The full picture will emerge in time.