Pepsi Challenged? – Q3 Earnings Preview

by Dan September 26, 2016 12:34 pm • Trade Ideas

Event: Pepsi (PEP) is scheduled to report its Q3 results Thursday morning prior to the open. The options market is implying about a 2%* one day post earnings move which is rich to the 4 qtr average of about 1% but basically in line with the 10 year average.

*with the stock very near $107, the Sept30th weekly 107 straddle (call premium plus the put premium) is offered at $2.20 (or about 2% of the stock price), if you bought that, and thus the implied move, you would need a move above $109.20, or below $104.80 to make money by Friday’s close.  

Price Action / Technicals: PEP has out-performed the broad market, up 7.5% ytd, vs the S&P 500 (SPX) up 2.5%, and its main competitor Coca-Cola (KO) down 1% ytd. For the most part consumer staple stocks have out-performed in 2016, with the XLP, the etf that tracks the sector is up 7.5% ytd, led by Proctor & Gamble (PG), Philip Morris (PM) & Altria (MO) as investors have reached for defensive stocks with out-sized yields.

Interestingly, while PEP mildly out-performed the SPX during the financial crisis (down about 45% peak to trough vs the SPX 54%) it has under-performed from the 2009 lows, up 150% vs 220%.  The stock appears to have very healthy support around nice round numbers, the recent breakout at $100, and the 2013 breakout at $80, with the long term uptrend right in the middle at $90:

[caption id="attachment_66587" align="aligncenter" width="600"]PEP since 2007 from Bloomberg PEP since 2007 from Bloomberg[/caption]

Taking a shorter term view the stock has been in a downtrend since the all time highs in mid July, when defensive stocks were in demand (post Brexit and with the 10 year treasury yield having just made a new low at 1.3%). A break below the uptrend on a meaningful guide down puts a re-test of $100 support level in play:

[caption id="attachment_66588" align="aligncenter" width="600"]PEP 1 yr chart from Bloomberg PEP 1 yr chart from Bloomberg[/caption]

My View into the Print: in 2015, 56% of their sales came from outside the U.S., where much of their future growth is expected.  In 2015 the U.S. dollar index (DXY) was up about 85% vs its ytd decline of about 3.5% which should help moderate the adverse affects of collecting sales in dollars abroad.  In 2015, eps and sales declined 1% yoy for PEP. This year, despite an expected 4% increase in EPS, sales are expected to decline 1%.  For this, investors are paying 22.5x expected 2016 eps, very near a 10 year high P/E:

[caption id="attachment_66590" align="aligncenter" width="561"]PEP 10 yr expected P/E chart from Bloomberg PEP 10 yr expected P/E chart from Bloomberg[/caption]

So in sum, no growth, potential headwinds from strengthening dollar, expensive valuation vs strong capital return but defensive.

Volatility: Implied volatility (the price of options) is quite low going into this event. The 14 vol in October is matching the lowest it’s been into an earnings release in the past 2 years, with typical 30 day vol typically in the high teens. Realized vol (the amount the stock is actually moving) is also quite low, an effect of a late summer where the stock barely moved at all as it consolidated around 108.


So that low vol means that directional bets are cheap. But it’s also saying that fireworks aren’t expected. As far as strikes to choose for those looking directionally, 103 and 108 are the moving averages the stock currently finds itself between, while 100 and 111 possibly the levels to target if looking out beyond the event itself (perhaps to December).

Buying low vol out a few months seems to be the play for those that want to pick a direction that captures this event and how the stock will react into year end. But the stock is usually not a big mover, and financing those sorts of bets makes the most sense, in the form of calendar spreads.

We’ll take a closer look if anything stocks out in particular closer to the event on Thursday.