In the battle of the giants, PepsiCo has stolen a march on Coca-Cola over the last year or so and its performance in the first half of the current fiscal year suggests it is still has the upper hand. Chris Brook-Carter analyses PepsiCo's recently published second-quarter results and looks ahead to the rest of the year.

Most market analysts and watchers seemed to agree towards the end of last year that PepsiCo had very successfully given its more illustrious soft drink rival Coca-Cola a bloody nose in their annual battle for market share and investor confidence.

This has often been a fight won by Coca-Cola but last year saw Pepsi's broad portfolio of snacks and beverages steal a march on Coke, which continued to rely far more heavily on declining carbonated soft drinks (CSDs) in a market demanding something different.

If last week's second quarter 2005 results are anything to go by, PepsiCo CEO Steve Reinemund and Co are not yet ready to let Coke regain its balance without a further struggle.

Driven by a strong performance from it international division, PepsiCo reported a 13% rise in second-quarter earnings on July 12 to US$1.19 billion or US$0.70, some US$0.03 above consensus estimates.

Once again it was PepsiCo's diversified portfolio that allowed it to ride out some tough market conditions, particularly in the North American CSD market, and post these overall positive figures.

PepsiCo's US carbonated drinks business reflected the tough trading conditions in the sector and turned in a 4% fall in volumes. However, the group's overseas operations more than compensated, with international beverage volumes up 10% and international revenues, including snacks, up 15%.

"PepsiCo's portfolio strategy continued to show its strength with overall business growth slightly ahead of our estimates and stronger-than-expected PepsiCo International growth compensating for solid but nonetheless disappointing performance in North America," said Legg Mason analyst Mark Swartzberg.

Last year's performance was PepsiCo was impressive. This first half of this year, however, is something else, for two reasons.

First, it has been achieved in the context of a re-invigorated Coca-Cola system.  Last year saw the Coke machine in disarray, hit by poor marketing decisions and the loss of a number of key executives at the very top of the company.

Under the direction of new CEO Neville Isdell, Coke has been re-establishing a base from which to work, substantially upping its aggression in the marketplace (advertising spend is set to increase US$400m this year) and re-jigging its management team.

However, Coke is still over-reliant on the CSD category, garnering some 83% of its sales from soda. Pepsi, in contrast continues to benefit from moves in the last few years to move into healthier and trendier beverage choices.

The company's PBNA operations may have been hurt by the 4% fall in CSD volumes but that freefall was at least substantially offset by a 5% increase in non-carbonated beverage volume. Non-carbonated beverage volume growth was fuelled by double-digit growth in Aquafina and Propel fitness water and low-single-digit growth in Gatorade.

Meanwhile, PepsiCo International's beverage business was led by carbonated soft drinks growth in the high single-digits and non-carbonated beverage volume growth at a double-digit rate.

"We continue to benefit from consumer interest in healthier versions of many of our products," said Reinemund in last week's earnings conference call. He added that the company's Smart Spot system, which highlights its healthier beverage and food options to consumers, grew revenue in the mid-teens in the quarter.

The second reason these results are impressive is that they could be only the base for an even more successful second half to the year. Reinemund said that Pepsi plans to spend more on advertising and promotion in the second half  - he called the upcoming period "the greatest non-carb advertising calendar in our history".

And he added that recent innovations, which launched too late to be reflected in the first half figures, should drive the company forward in the third and fourth quarters, particularly in North America.

Talking of PBNA Reinemund said: "While we are never satisfied with a volume decline, I think we have to look at the quarter in context of the numbers we are lapping from last year. As we hit the easier comparison of the second half and benefit from new products innovation we expect to see a return to positive volume performance."

He added: "Much of the innovation has just launched and we didn't get the benefit in the second quarter. Although it's early, all the products are in line or ahead of expectations."

Furthermore, if PepsiCo is perturbed by the recent step up in aggression from Coke it is not showing it. "What we are starting to see from competition is what we expected in new product and spending. We are going to play our game which was to step up investment," said chief financial officer and president Indra K. Nooyi.

The investment, she added, would be directed behind marketing, advertising and promotion behind the portfolio of CSDs as well as a "significant increase in non-carb innovation".

All this confidence has been reflected in Pepsi updating its full-year earnings outlook, stating it now expects earnings per share for 2005 of US$2.56 to US$2.59, excluding the impact of the 53rd week. It was also reflected in the fighting rhetoric of the Pepsi executives, which should serve as a warning shot to Coke and great encouragement to Pepsi investors.

"This year we are offering profit guidance of 8%," said Nooyi. "So far it's going like clockwork, the only thing different is that the first half has been even stronger than we anticipated. Every quarter we get under our belt we feel more confident in our ability to deliver that number, in the face of stepped up competition and difficult CSD category."