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PepsiCo is scheduled to announce its earnings on Thursday, February 9. Once again the snack segment, and not the core soft drink business, is expected to lead the growth.

Recent acquisitions in Latin America will help the company delve deeper into high growth potential regions of the world.

PepsiCo competes with leading food & beverage companies around the world including Kraft Foods, Coca-Cola and Dr. Pepper Snapple.

We maintain a price estimate of $71, which is about 5% above the current market price.

See our complete analysis of PepsiCo

Snack Segment Continues To Do Well

PepsiCo possesses strong pricing power in the Latin American region. In the first nine months of 2011, net revenues and the operating profit witnessed a 17% growth even though the volumes increased by only 4%. The company also acquired Brazilian cookie maker Grupo Mabel in a deal estimated to be more than $500 million. PepsiCo is also looking to acquire Marilan Alimentos, the country’s fourth largest cookie maker. These are significant investments in a country which is the world’s second largest cookie and cracker producer.

The snack segment continues to perform strongly in Asia with volumes in India, China and the Middle East all witnessing a double digit growth in the first nine months of 2011. The growth in the snack segment can be attributed to product innovation suited to local consumer taste. Moreover, PepsiCo’s diverse portfolio with variegated pricing appeals to a large consumer base. Recently, the company also announced its plan to set up a $100 million plant in India to produce corn-based snacks.

Although high commodity prices have squeezed margins, we anticipate the company to maintain profitability as it has raised the prices of Frito-lay products and Gatorade drink last quarter. PepsiCo also announced it does not expect any significant impact of high commodity prices since the company was hedged against price volatility in the fourth quarter.

Soft Drinks Could Do a U-Turn in 2012

PepsiCo’s soft drink business including its namesake brand Pepsi, Mirinda and 7UP have witnessed declining volumes in the last few years. CEO Indra Nooyi has often been criticized for neglecting the core soft drink business and focusing excessively on building a healthier portfolio.

Pepsi’s market share in the U.S. Carbonated Soft Drinks market has been declining. Exacerbating the matter is the fact that the market size has also shown a negative growth.

In the recent strategic review of the company, PepsiCo has decided to renew its push into the soft drink business with increased marketing spend. Indeed, in the soft drinks industry, we find a strong correlation between sales and the amount of money spent on advertising.

PepsiCo plans to raise the marketing budget of its namesake cola and other drinks by 50% to a whopping $1.7 billion this year. ^[1] We could potentially see reinvigorated cola wars, one in which Pepsi might snatch some of Coca Cola’s market share.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:

1. PepsiCo May Boost Marketing Budget to Take On Coca-Cola: Retail, January 30, 2012, Business Week [↩]

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Low natural gas prices in the U.S. have forced ConocoPhillips and other players like Chesapeake Energy to announce production cuts over the past few weeks.

Lower supplies resulted in gas prices rising 17 cents to $2.55 / thousand cubic feet (tcf) after an EIA report indicated that gas inventory levels had declined more than expected in the last week.

Gas prices had touched 10 year lows at $2.35 /tcf earlier, which was less than half the price level seen in 2010 as a mild winter exacerbated the oversupply situation in the U.S.

A popular though imperfect gauge of natural gas prices is the U.S. Natural Gas Fund (UNG).  That fund has dropped by more than 50% since June 2011.

We have a $79 price estimate for ConocoPhillips, which is at a 10% premium to its current market estimate.

Click here for our full analysis of ConcoPhillips

Lower production

Analysts expect that more producers will follow Chesapeake and ConocoPhillips in cutting production targets in the future. Although the overall gas production in the U.S. will continue to increase over the next two years, the rate of increase will be tempered by low prices. Underground inventory levels in the U.S. saw less than expected decrease in the winter resulting in low gas prices. Low prices are hampering the profitability of gas production in the U.S., which has increased to record levels in the past years on the back of shale exploration, which now contributes to a third of the country’s total gas supply.

Low domestic prices are also forcing players to consider exporting surplus production to Asian markets by converting gas into LNG. Over the past two months, two Asian customers have signed supply contracts with American gas producers.

Gas prices in the U.S. are presently lagging international benchmarks. Benchmark crude oil prices also saw small declines in the country because of falling demand. According to government agencies, weekly demand for petroleum products dropped by 4% compared over the same period last year. Gasoline, diesel and heating oil demand also fell in the period.

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Deutsche Bank ended up with a pre-tax loss of €351 million ($460 million) for the fourth quarter of 2011, bringing to an end a difficult year for the German bank. ^[1] Interestingly, the company managed to avoid reporting a net loss for the period with income tax benefits coming to its rescue.

Although analysts had forecast soft numbers from the bank as the quarter was plagued by fears of European debt issues spreading, the reported results were worse than anticipated while competitors Goldman Sachs and Morgan Stanley were able to beat expectations.

With Deutsche Bank contemplating the sale of its stable asset management business, its volatile investment banking operations could become even more important to its business model.

We reiterate our $49 price estimate for Deutsche Bank’s stock, and believe that the 10% premium over current market prices can be attributed to the pessimistic sentiment among investors toward banks in the wake of Europe’s debt situation.

See our full analysis for Deutsche Bank

Deutsche Bank Couldn’t Have Done Much About Its Investment Banking Business

Deutsche Bank’s numbers were no doubt weak. But one cannot forget the fact that the German bank has a substantial exposure to the peripheral European nations which have been hit worst by the debt crisis. The results lend support to one fact this is a tough time to be a European investment bank.

Deutsche Bank’s investment banking operations continued the bad run which began in Q3 2011. Volatile market conditions that were prevalent in the second half of 2011 were hardly conducive to trading activities. The slowdown also dried up demand for advisory services, with companies across the globe putting off capital raising or restructuring plans.

One look at the quarterly income statement shows what went wrong – sales & trading activities, which normally bring in between €2.5 billion to €3 billion ($3.3 billion to $3.9 billion) in quarterly revenues for the bank, ended up only bringing in about €1.6 billion ($2.1 billion) for Q4 2011.

According to our estimates, sales & trading contributes to almost a third of Deutsche Bank’s value, and the volatility associated with this business will always be a cause for concern.

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Notes:

1. Deutsche Bank reported net income of EUR 4.3 billion for the full year 2011, Deutsche Bank Press Releases, Feb 2 2012 [↩]

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The legal battle for patents in the smartphone market is getting more complicated of late. Apple saw a couple of setbacks last week.

First, it was forced to remove iPhone 4 and 3GS from its German online store as the models were believed to infringe certain patents of Motorola Mobility. ^[1] Then a German court granted Motorola’s request to permanently ban Apple’s push e-mail services, a key feature of its iCloud offering.

This is indeed a big blow to Apple which is already finding itself mired in litigation issues with Samsung and HTC. Incidentally, Google is in the process of acquiring Motorola Mobility for a valuation of $12.5 billion, and hence this win indirectly underscores the intense battle between Google and Apple.

Our $550 price estimate for Apple stock is about 20% above the market price.

See our complete analysis of Apple here

Apple Mired with Patent Issues

This is not the first time that Apple has lost a patent infringement case. A few months back, the U.S. International Trade Commission ruling that Motorola Mobility did not violate Apple’s patents dealt a blow to the iPhone maker (Read Motorola Deals Apple a Small Setback With ITC Ruling). Apple had asked the commission to block Motorola phones such as the Droid and Droid X, claiming they infringed on its patents.

A few weeks ago, Motorola won the injunction against Apple’s devices in Germany based on an essential GPRS patent. ^[2]

Google Benefiting from Apple’s Situation

Google and Apple are the top two contenders in the smartphone market and hence there is a lot at stake for these players. Google’s Android is still the largest player in the smartphone operating system market, but Apple recently became the number one smartphone vendor in the world in Q4 2011 overtaking Samsung. ^[3]

However, if Apple continues to lose patent battles, it could hurt its competitive position in the long term. While Google would be the biggest beneficiary from Apple’s loss. With Motorola scoring a decent number of legal victories over Apple, Google’s decision to acquire Motorola for its patent portfolio is increasingly looking like a wise move.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:

1. Apple TEMPORARILY removed products from German online store due to Motorola injunction based on FRAND patent, FOSS Patents, February 3rd, 2012 [↩]
2. German Court Rules in Favor of Motorola Mobility in Apple Litigation, Press Release, December 9th, 2011 [↩]
3. Apple Becomes World?s Largest Smartphone Vendor in Q4 2011, Strategy Analytics, January 26th, 2012 [↩]

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Amazon.com has a history of treading on wafer-thin margins, but it seems that in 2011, investor patience was tested to the limit. Adjusted EBITDA margins fell from around 7% in 2010 to around 5.2% in 2011. ^[1]

While the stock suffered quite unsurprisingly, the big question is whether the company intends to put a brake on costs anytime soon. ‘

Amazon competes in the e-commerce and e-content space with companies like eBay and Apple, and against a broad swath of traditional retailers such as Best Buy and Wal-Mart.

See our full analysis for Amazon’s stock here

Technology and Content Costs Might See a Decline

The main spikes in expenses for 2011 have clearly been fulfillment and technology & content. The fulfillment increase has come about as Amazon invested heavily in setting up more warehouses, as well as to support the Amazon Prime feature, which guarantees free shipping within 2 days. Technology related costs have shown an expected increase as the company invested heavily in the Kindle Fire tablet, as well as by acquiring more content from publishers.

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For the near-term, it is unlikely that fulfillment costs will show a significant decline since more Amazon Prime subscribers (which Amazon wants) means additional pressures to deliver products on time, and hence a bigger need for further storage centers. Technology & content costs however have shown a decline from around 6% to 4% of net sales from Q3 to Q4 of 2011. This might be an indication that Amazon is easing on product development as the Kindle Fire reaps the desired media consumption.

CEO Jeff Bezos has usually prioritized a long-term growth vision for Amazon, which means that the company could continue investing heavily on Kindle Fire upgrades as well as content partnerships like it did in 2011. If that happens, one can expect margins to stay worryingly low.

We have a revised price estimate of $205 for Amazon’s stock. The updated price has been formulated based on the change in our forecasts for Amazon’s revenue and margins as well a change in the company’s net cash/debt position.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:

1. Amazon.com Announces Fourth Quarter Sales up 35% to $17.43 billion; Kindle Device Sales Nearly Triple During the Holidays, Amazon Press Releases, 31st Jan 2012 [↩]

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Green Mountain Coffee Roasters sells more than 200 varieties of K-Cup portion packs including brands of coffee, tea, hot apple cider, iced teas, hot cocoa and other dairy-based beverages.

Recently, Esio Beverage, a new single-serve beverage maker, announced its plans to sell its single-serve beverage machine at retailers, including Wal-Mart. We believe this could pose some competition to GMCR which presently enjoys a dominant position in the single serve coffee market, especially if it can team up with a major distribution channel like Wal-Mart.

In coffee makers, GMCR competes with Robert Bosch, Nestle, Mars, Bunn-O-Matic and Phillips Electronics, among others.

See our full analysis of Green Mountain Coffee Roasters and $61.60 price estimate here.

Competition Intensifying in Niche Single Serve Coffee Market

Single serve coffee formats, a category that was in the nascent stage approximately five years ago, now accounts for 7.5% of the U.S. retail coffee sales, according to Packaged Facts. ^[1] The single serve market has been a major growth driver of the overall coffee industry in the U.S. According to a recent study by National Coffee Association of USA, penetration in the single serve space is growing at an average of 1% per year.

GMCR has a dominant position in this market. Its K-Cup portion packs and Keurig single-cup brewers and related accessories contribute a significant proportion to its revenues, with an approximate share of 84% in 2011.

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The introduction of Esio Beverage System at Wal-Mart stores could pose stiff competition to GMCR. Going by reports, the price per serving is expected to be much lower than the average cost of Keurig’s K-Cups, which range from 60 cents to 90 cents each. However, we believe that Esio Beverage will have to work on building its brand name in the single serve coffee industry. GMCR being a market leader enjoys a loyal customer base and strong brand recognition.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:

1. Single-Serve Now 7.5% Of U.S. Coffee Sales, Media Post [↩]

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Intimate apparel retailer Limited Brands reported comparable store sales increase of 9% for the four weeks ended January 28, 2012, compared to the same period last year. ^[1] Victoria’s Secret was yet again the major growth driver for the company, with comp sales increase of 17%.

Additionally, the company also adjusted its fourth quarter earnings per share at the high end of its previous guidance of $1.42-$1.46.

Limited Brands is a specialty apparel retailer focused on lingerie, beauty and personal care products competing with the likes of Abercrombie & Fitch , American Eagle Outfitters, Ann and Gap.

See our full analysis of Limited Brands

Victoria’s Secret Drives Limited’s January Sales

Victoria’s Secret was the major contributor to Limited’s January sales results, with comp sales increasing 17% for the four weeks ended January 28, 2012, compared to the same period in 2011.

Although Limited’s other two major brands Bath & Body Works and La Senza showed negative comp sales for the month, solid performance by Victoria’s Secret ensured that Limited ended January on a positive note.

We believe that the company benefited from continuing smart promotions of Victoria’s Secret on Facebook, apart from strong brand identity of Victoria’s Secret.

Check our article: Limited Gets a Lift from Victoria’s Secret Facebook Campaign This Holiday Season

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:

1. Limited Brands reports January sales results, Source: Limited’s IR [↩]

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Zynga is the leader in social gaming and is charging forward in the mobile gaming space by acquiring mobile gaming studios and launching new mobile games on iOS and Android.

We know that almost all of Zynga’s revenues are generated by Facebook, but recently, after Facebook filed its S-1 filing for IPO, it was revealed that Facebook depends on Zynga, too, and in a big way. According to its S-1 filing, Zynga accounted for more than 12% of Facebook’s overall revenue in 2011. Facebook even explicitly listed its dependence on Zynga as a risk factor.

Zynga competes primarily with Electronic Arts, Playdom–which was recently acquired by Disney–and other independent social gaming studios. New games account for over 40% of Zynga’s $10.20 Trefis price estimate. Our price estimate for Zynga accounts for dilution due to stock options and restricted stock, which results in a deflated value.

Check out our complete analysis of Zynga

Facebook’s rising tide lifts all social boats

A lot of companies whose businesses are tied to Facebook saw their stock prices rise following the IPO filing. Zynga, which was trading under $10, its IPO price, since it went public, saw its stock price rise to an all-time high, before settling almost 25% above its IPO price at $12.4.

Since there is a high degree of correlation between Zynga’s revenue and Facebook’s revenue, some analysis of Facebook’s Q4 2011 numbers suggest that Zynga will see significant revenue growth in Q4 2011, much higher than expectations. ^[1]

New games and foray in online gambling to drive Zynga’s growth

Zynga is currently planning to enter the online gambling market with its Casino social games like Poker and Bingo. We expect a significant revenue boost should Zynga succeed in entering the lucrative online gambling market in the coming years.

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Zynga’s other new games like Hidden Chronicles and Scramble with Friends are also expected to attract more and more casual gamers in the coming years, and generate increasing amounts of revenue.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:

1. Did Facebook Just Spill the Beans on Zynga’s Fourth Quarter?, AllThingsD [↩]

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A funny thing happened on the way to the market close on Friday.  Bloomberg News released a story that the Federal Reserve Bank of New York received another unsolicited bid for a block of the residential mortgage-backed securities (MBS) bonds they couldn’t give away last summer.

In response, so the story goes, the Fed may auction off as early as this week approximately $6 billion in additional bonds, on top of the $7 billion that traded to on January 19. Back then, the catalyst for that trade was an unsolicited bid from Goldman, Sachs.  The Fed put the list out to competitive auction to four dealers: Goldman, Credit Suisse, Barclays and Bank of America.  Somewhat surprisingly, at least for this observer, those bonds traded away  to Credit Suisse.

The newest round of bidding would be for bonds residing in the Maiden Lane II portfolio, securities the New York Fed acquired in the fall of 2008 as part of the government intervention to support AIG.  Back then, the portfolio was valued at approximately $20 billion, but as of September 2011, the Fed reported a market value of $9.6 billion. (Click here for the details from the New York Fed).

Assuming the January 19 sales netted roughly $3 billion, the portfolio is now probably worth around $6 billion.  With this most recent bid, the remaining portfolio will be down to a very manageable $3 billion to $4 billion area.

Since November, the market has seen a powerful rally in the $1.1 trillion non-agency MBS market.

For example, from a low of 40, the ABX 06-2 AAA index, a barometer of senior subprime MBS originated in the first half of 2006, closed at 51.5 on Friday, up close to 30% (see graph from Markit).

Readers of this blog may recall some bullish “risk on” prognostications subsequent to the last sale in January.  At the time, I argued that the ECB’s LTRO operation in December was a game changer.  Until then, the market was concerned about the prospect of European bank selling of any and all dollar assets.  Those fears were taken off the table and the ECB has announced another LTRO operation for later this month.

 

CBOE Traders

By Rocky White

Even though an option contract’s value is based on the stock price, a stock picker is not necessarily going to be a successful options trader. The main difference is that options have expiration dates. Therefore, an option trader not only has to be right on the stock’s direction, but he has to get that move within a specified time frame.

Stocks are often compared simply by the size of their returns over a certain time period. But impressive stock returns do not necessarily correlate into great option trades. Two option-specific items that stock traders don’t have to deal with are the strike price and implied volatility of the contract. These features make option trading a completely different animal from stock trading. So, let’s look at effective ways to rank stocks for option traders, not stock pickers.

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Comparing MCD & PIR Option Returns: Below is a chart showing stock returns for McDonald’s (MCD) and Pier 1 Imports (PIR) since 2011. Both stocks have done very well, with PIR outgaining MCD. But have these stocks been kind to short-term option players? That’s what we’d like to know.

So, let’s consider a short-term options trader who typically holds a position for two weeks. How did these two stocks perform for him? To evaluate their performance, I assumed a trader could theoretically purchase a two-week option on the stock every single day. I also assumed he bought a strike price that was exactly 5% in-the-money.

To find the prices of these hypothetical options, you need an implied volatility, which I derived by finding implieds on near-term options which were about 5% in-the-money. Furthermore, I assumed the trader held the options for the entire two weeks, and closed them out at intrinsic value when they expired.

How would a trader have done with these two stocks, had he purchased one of these hypothetical call options every single day since 2011? The table below summarizes his results, which many may find pretty shocking. Notice that even though PIR outpaced MCD during this time frame, buying calls on PIR would have resulted in a loss of 8% per trade, while McDonald’s would have gained about 18% per trade.

The stock returns in the table are not up-to-date. These are as of a couple weeks ago, when the last two-week option could have been purchased and closed.

The percentage of positive trades is revealing, as well. For MCD, without doing any analysis of the stock, but just randomly picking a day to purchase a two-week option, there was a 67% chance of that option being profitable. For PIR, the chance of a profitable call trade was just 41%.

How did this happen? Why is MCD such a superior stock for options traders, compared to PIR, which had a better stock return over the time frame considered? You can get a sense of this by looking at how choppy the PIR returns are compared to MCD.

For example, look at the stock return from January through July 2011. If you were purchasing call options on PIR, you would have made huge money in early April, when the stock spiked higher. You probably would have made money in late June, as well. Other than that, your option trades would be taking steep losses. MCD, on the other hand, steadily climbed from mid-March through July, when option traders would have consistently made money.