Since the stock market rally reached a pinnacle nearly two weeks ago, the Dow Jones Industrial Average has lost about 3.3% while the Standard & Poor’s 500 Index has fallen about 3.7%. And if this week’s earnings report come in below expectations, the rally that helped stock prices surge more than 50% could come to an abrupt end.

Fortunately, many of the companies set to report earnings this week are traditionally strong performers and for the most part, companies that have weathered the financial crisis. But not all of them have met Wall Street’s expectations.

The quarterly results for five companies in particular – Yum! Brands Inc. (NYSE: YUM), Alcoa Inc. (NYSE: AA), Costco Wholesale Corp. (Nasdaq: COST), Monsanto Corp. (NYSE: MON) and PepsiCo Inc. (NYSE: PEP) – will of particular interest to investors.

Yum! Brands Inc.

Scheduled to report today (Tuesday), the Louisville, Ky.-based Yum! will be one of the first companies to report its quarterly take.

As owner of the Taco Bell, Kentucky Fried Chicken (KFC) and Pizza Hut brands, Yum! is the world’s largest restaurant company. Even more impressive, the company has beaten the market’s consensus forecast in the last four quarterly reporting periods.

Analysts’ estimates for the quarter ending September 2009 range from a low of 52 cents a share to a high of 63 cents a share, with a consensus of $0.59 a share. Yum will lean heavily on its international business if it’s going to continue its trend of topping analysts’ estimates.

Yum! is a well balanced company with about 41% of its 2008 operating profit coming from the United States and the rest from overseas – particularly China.

By 2013, China will account for 40% of Yum’s operating profit – up from 28% in 2008 – while the United States and the rest of the world will each account for a 30% share, according to company projections.

KFC, in particular, has long seen its most robust growth coming from China, with less than 10% of its franchises on the mainland accounting for more than a quarter of the company’s earnings.

Yum! added 328 new restaurants in the second quarter, including 118 in Mainland China.

“Yum!’s global growth potential, consistent performance and track record of generating strong free cash flow give us the confidence and ability to return significant cash to our shareholders even in these challenging economic times,” said Yum! Chief Executive Officer David Novak.

An analyst with Credit Suisse Group AG (NYSE ADR: CS) earlier this week told Barron’s that Yum! shares deserve a better premium because of its large international footprint and ongoing reallocation of capital.

Yum! shares should trade at a premium to their peer group and could climb nearly 25%, a the analyst said.

Shares of Yum! surged 5.13% yesterday to close at $34.85.

Alcoa Inc.

Though its release comes a day after Yum’s, Alcoa’s quarterly report marks the unofficial start of earnings season.

Hit hard by the collapse of commodities prices and sluggish industrial demand, Alcoa has missed earnings expectations in three of the past four quarters. And the company’s latest earnings report will likely show that its struggles continued, albeit at a slower pace.

Alcoa is expected to report a net loss of 12 cents per share for the three months that ended in September. That’s down substantially from a profit of 37 cents a share in the same period last year, but would be a marked improvement on the 32 cents a share loss the company posted in the second quarter.

Indeed, Alcoa’s earnings will provide an important look at just how far global demand for industrial metals has come. Hopes are high, as Alcoa stock has surged more than 143% since mid-March.

Deutsche Bank AG (NYSE: DB) analyst Jorge Beristain has increased his rating of Pittsburgh-based Alcoa to “Buy” from “Hold” and increased his price target to $17 from $12.

The upgrade partially reflects Deutsche Bank’s higher price projections for base metals. The bank sees base metal prices climbing an average of 31% next year, on account of strong third-quarter “price surges” and increased demand from China, Beristain said in a note to clients.

“China’s seemingly insatiable appetite for industrial raw materials has led to record high imports in many metals and a consequent tightening in market balances,” he said.

Alcoa’s stock rose 4.68% in trading yesterday, to close at $13.42 a share.

Costco Wholesale Corp.

Costco is the largest membership warehouse club chain in the world by sales volume. That makes it an ideal choice for cost-conscious consumers. Costco has enjoyed seven straight years of earnings growth, but the company’s past two quarters have disappointed investors.

The third time might be the charm for the nation’s largest warehouse chain. William Blair & Co. LLC analyst Mark Miller last month upgraded the stock to “Outperform” from “Market Perform” and after the company stepped up sales in August.

Sales at established locations declined 2%, beating Wall Street expectations for a larger 5.7% decline.

“With the step-up in sales during August and positive takeaways from our meeting last week with [Costco Chief Financial Officer] Richard Galanti and [Vice President of Financial Planning and Investor Relations] Bob Nelson, we are more confident that sales and earnings could meaningfully surpass Street expectations over the next year,” said Miller.

Like Yum!, Costco could receive a significant bump from its overseas operations, as recent store openings in Asia have been strong and the dollar has weakened.

For the third quarter, the average analysts’ estimate is for a profit of 76 cents a share – a 17% drop from the 92 cents a share it earned in the same quarter last year.

Costco CEO Jim Sinegal said earlier this month in an interview with Motley Fool that he expects his company to turn around regardless of whether or not the economy experiences a quick recovery.

“We can always blame bad sales on weather and on economic conditions and everything else,” he said. “But when we have the right merchandise out on the floor, it sells. … [We] don’t like the fact that the [average customer] basket is down, but we certainly like the fact that the customers are coming back more frequently and, as things turn, they will start to buy again. Now it is on us to get the hot merchandise.”

Costco stock edged up 0.73% yesterday to close at $56.88 a share.

Monsanto Co.

As the world’s largest producer of genetically modified seeds, Monsanto is a closely watched biotech bellwether. Like Alcoa, Monsanto was hit in recent quarters by a drop in commodities prices, as well as a drop in demand for its products.

However, the company announced an acquisition, a partnership, and a divestiture in its fiscal fourth quarter. It is expected to squeeze out a one cent per share profit, compared to three cents per share loss in the same quarter last year.

Monsanto’s acquisition of WestBred LLC – a Montana-based company that specializes in wheat germplasm – will bring wheat into its seeds and traits portfolio, and its joint venture with Dole Fresh Vegetables, Inc. will put more genetically modified vegetables on Monsanto’s plate. Meanwhile, Monsanto’s divestiture of its global sunflower assets to Syngenta brought in $160 million.

The company also shed 9,000 employees in a bid to cut costs, and despite being heavily targeted by anti-trust groups and chief rival E.I. du Pont de Nemours & Co. (NYSE: DD), Monsanto insists it’s on track to more than double its 2007 profit by the year 2012.

“We have committed to using our technology to double yields in our three core crops – corn, soybeans and cotton – by 2030, while reducing our use of key resources by one-third per unit produced,” said Monsanto Chairman and CEO Hugh Grant. “Innovation has us well on our way to achieving this, with our most robust pipeline ever. We’re on the verge of an unprecedented technology explosion that will deliver the types of products growers want most – those that offer greater yield and value.”

By 2012, Monsanto expects its gross profit from its core seeds and traits business to be between $7.3 billion and $7.5 billion – about 2.5 times its 2007 level. Grant said this increase will be facilitated by the development of seven new “high impact technologies” that by 2020 will boost revenue by $3 billion.

Monsanto has reported better-than-expected earnings in the past three quarters, and at Monday’s close of $74.85 a share is an undervalued stock according to Morningstar.

“Monsanto is a fierce competitor that continues to dominate a market that it essentially created more than a decade ago,” said Morningstar senior analyst Ben Johnson. “Through its ongoing commitment to research and development and assertive capital allocation, the company has positioned itself to grow value for its shareholders over the long haul.”

PepsicCo Inc.

Of all the companies reporting this week, PepsiCo has generated the most buzz. Bullish speculators yesterday piled into PepsiCo call options after Deutsche Bank raised its earnings for the salty-snack-and-soda giant.

Call volume surged by nearly 700%, according to optionMonster.

Deutsche Bank raised its price target for PepsiCo shares, which closed yesterday at $60.85, to $70 from $66. The bank maintained its buy rating on the stock, and said shares have been negatively affected by an “unwarranted deal overhang” related to the company’s acquisition of Pepsi Bottling Group Inc (NYSE: PBG).

PepsiCo in August said it would merge with Pepsi Bottling, as well as invest in Russia, during the three months that ended in September, and is expected to post a profit of $1.02 per share – four cents per share less than a year ago. Revenue for the quarter is expected to come to $11.3 billion, about the same as last year.

PepsiCo has only missed expectations in one of the past four quarters, and by just two cents at that.

Source: The Five Stocks to Watch This Week

However, the stock has underperformed since the market began its rebound on March 10. And since the end of March, Pepsi’s shares have lagged those of arch rival, The Coca-Cola Co. (NYSE: KO), since the end of March, as well.  I recommended Coca Cola last week after the company reported stellar growth in the emerging markets.

While Pepsi’s less-than-stellar performance is not yet a major concern, the trend is discomforting.  In addition, there has been a major divergence in the strategies of these two companies.

While both Coke and Pepsi divested of their bottling operations many years ago, Pepsi just agreed to buy back two of them: Pepsi Bottling Group Inc. (NYSE: PBG) and PepsiAmericas Inc. (NYSE: PAS). And it paid a stiff premium in each deal, about 24% and 23%, respectively, above their pre-deal market prices. The total value of the deal was a cool $7.8 billion.

Now allow me to say that these companies are impressive operations by themselves:

• Pepsi Bottling Group is PepsiCo’s largest bottler. The company takes in $14 billion a year and operates in the United States, Canada, Greece, Mexico, Russia, Spain and Turkey, and boasts 67,000 employees.

• Pepsi Americas is PepsiCo’s second-largest bottler. It brings in $4.9 billion annually from operations in the United States, Ukraine, Poland, Romania, Hungary, the Czech Republic and Slovakia.  In addition, its new joint venture covers the Caribbean and Central America.

So why bother with these acquisitions?

The justification for this move is that “in a rapidly changing, more-complicated global market, a leaner, more agile business model is pretty important,” said Pepsi Bottling Group Chief Executive Officer Eric J. Foss.

Pepsi touted the tie-up itself, citing such advantages as attempting to create a more-flexible, efficient and competitive system that is more inclusive of other Pepsi brands.

The idea is that a merged operation will allow for much faster introduction of new products, for bundled offers, for enhanced customer service, and for cost savings from redundancies and economies of scale.

Sure, we can buy into many of those ideas, which are sure to result in some gains.  In fact, we can even envision the many new marketing initiatives that will result from these acquisitions.

But make no mistake: What has pushed Pepsi to go in this direction is the superiority of Coca Cola in the emerging markets.  While both firms prided themselves on product innovation and marketing, Coca-Cola has come out on top, as I wrote last week.

In addition, the capital requirements of a bottling and distribution operation are very high and the return on equity is much lower than Coca-Cola’s core business of creating the product, marketing it, and selling the concentrate and bottling rights to bottlers.  This decision will make less cash available in the immediate future for stock buybacks and dividend increases and represents a big gamble.

There are two pressing questions to have in mind:

• Will the marketing synergies PepsiCo claims it will garner from the deals be successful in winning market share away from its rival and thus justify the added capital requirements of the newly acquired operations?
• And will Pepsi be able to capture the synergies from the merger fast enough?

What’s for sure is that Pepsi’s action goes against its decision to concentrate on its core competencies. Management theory has proven time and again that companies should concentrate in one segment of the entire value chain (in Coca Coal’s case, product innovation and marketing) and leave the less-attractive and less-profitable areas to others.

Furthermore, it’s clear to me that “asset-light” companies – firms such as C.H. Robinson Worldwide Inc. (NYSE: CHRW), which divested assets that have large financing requirements and that carry large fixed costs – reduce the cyclicality of the business, and thus reduce the risks to profits from economic downturns.  That means “asset-light” companies are preferable to “asset-heavy” companies.

Therefore, my bias is against the added complexity and capital requirements involved with the Pepsi deal.  And we must now wait to see if the company can deliver on the two key questions above.  But we can never count out Pepsi’s innovation and resiliency, and so we will give them the benefit of the doubt.

PepsiCo stock closed down 9 cents, or 0.16%, at $57.74 a share Friday. That’s up 32% from its hit 52-week low of $43.78, reached in Early March.

Recommendation: “Hold” PepsiCo Inc. (NYSE: PEP), but do not add to your position, and give preference to Coca Cola’s stock – at least until Pepsi is able to prove that it can execute the merger efficiencies and win market share from its arch-rival (**).

** Special Note of Disclosure: Horacio Marquez holds no interest in PepsiCo Inc.

Source: Buy, Sell or Hold: Will PepsiCo Inc.’s (NYSE: PEP) Recent Acquisitions Pay Off?

Source: Investment News Briefs Thursday, July 9, 2009

• The housing market showed further signs of bottoming in April, as pending sales of previously owned U.S. homes saw their biggest monthly gain in seven and a half years, the National Association of Realtors reported. The number of Americans signing contracts to buy previously owned homes climbed 6.7% in April, more than forecast and the fourth increase in five months. The report supports the case for a housing bottom made in Money Morning on Monday, where it was noted that housing prices are starting to move upward in western U.S. markets and should soon slowly begin to rise in hard-hit east coast markets.  “Based on what we just heard, we are now formally calling for the end of the housing depression and that we increasingly think that the housing market is beginning to turn up. All signs are pointing to a bottoming out now of the housing market” Bernard Baumohl, Chief Global Economist at the Princeton-New Jersey based Economic Outlook Group, told Reuters.

• Detroit’s ailing Big Three automakers, all reported that May sales in the U.S. fell less than analysts’ estimates while Toyota Motor Corp. (ADR NYSE: TM) and Honda Motor Co. (ADR NYSE: HMC) did worse than expected. Sales at General Motors Corp. (NYSE: GM) dropped 30% from last year, Ford Motor Co.’s (NYSE: F) sales fell only 24% and Chrysler LLC plummeted 47%, better than estimates, as shoppers returned to showrooms.  Deliveries at Toyota plunged 41% and Honda plunged 42%. Among Japanese carmakers, only Nissan Corp sales exceeded estimates, falling only 33%, Bloomberg reported.

• Microsoft Corp (Nasdaq: MSFT) said on Tuesday its new Windows 7 operating system, which will replace the unpopular Vista, will be available on October 22, well ahead of its original schedule and in time for the holiday shopping season, Reuters reported.  Windows 7 was originally scheduled to launch at the start of next year, but Microsoft confirmed last month that it would push up the schedule to allow sales during the year’s busiest buying period.

• The U.S. Federal Reserve Bank has successfully pulled the economy back from the brink, Dallas Federal Reserve Bank President Richard Fisher said yesterday (Tuesday).  The Fed official also said that conditions are “getting less worse” over time and the Fed needs to unwind its new, expansive credit programs as soon as it can, Reuters reported.  Furthermore, the U.S. central bank needs to make it clear it will not “monetize” the rapid expansion of U.S. debt, Fisher told a gathering of community leaders at a Dallas Fed event.

• Unemployment in Europe rose to 8.6% in April, up from 8.4% in March and 6.8% during the same period last year. Although the economic downturn in Europe is showing signs of slowing, the employment rate typically lags behind economic health.

• Pepsi Bottling Group Inc. (NYSE: PBG) Chairman and Chief Executive Officer Eric Foss is being promised a minimum $16.5 million in severance pay and stock benefits if PepsiCo Inc.’s (NYSE: PEP) takeover succeeds. He earned $6.1 million in total compensation last year. Pepsi Bottling, along with PepsiAmericas Inc. (NYSE: PAS) rejected a $6 billion acquisition attempt by PepsiCo, calling it “grossly inadequate” and “not acceptable.” Pepsi Bottling and PepsiCo are now locked up in a lawsuit, with PepsiCo accusing Pepsi Bottling of adopting a “poison pill” takeover defense that restricts its rights as a shareholder.

Source: Investment News Briefs Wednesday, June 3, 2009