Dueling Fools Coke vs. Pepsi
Coke Argument

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Dueling Fools
By Paul Larson (TMF Parlay)
April 4, 2001

Though it would have been difficult to imagine not long ago, I think I am playing the role of the underdog in this Duel by arguing for Coke. As a company, Pepsi has made all the right moves in last few years while Coke has floundered. Nevertheless, Coke's long-term positioning remains solid, and the company is poised for a strong comeback.

First, consider Coke's massive branding strength. The company is very proud to note that "Coke" is the world's second-most recognized expression, just behind "OK." Coke is the world's best-selling soft drink, and Diet Coke is number three. Between the company's branding strength and high-quality products, Coca-Cola owns roughly half of the worldwide market for soft drinks.

The soft drink business is beautifully simple and has some attractive financial attributes. People get thirsty, and people like sugar. When the need comes to quench someone's thirst, Coca-Cola's massive worldwide distribution capacity makes sure that a Coke is within easy reach of anyone desiring a drink.

The low price point at which Coke's products are priced, typically a dollar or less per serving, gives the company a modest amount of pricing power. People don't think twice about a few extra pennies and nickels, and these extra coins add up to some serious cash when multiplied over billions of transactions.

Coke has also taken up residence in the sweet spot of its business. The company only sells the syrup for its drinks and leaves the capital-intensive business of bottling to its partners. This means that Coke can sit back and watch the billions roll in on a comparatively light financial model.

I'm sure Rick will be sure to explain this, but Coke has hit a bit of a rough patch over the last three years. Externally, Coke was dragged down by the Asian economic crisis, a product recall in Europe, and problems that led to asset write-downs in Russia. Internally, a bevy of onetime charges -- from the company's bottling partners, a restructuring that included thousands of layoffs, and a management shakeup -- have rattled the company to its roots.

Luckily, all these problems are transient, and Coke stands a great chance of correcting them and getting profits back up to the levels achieved circa 1997. Back then, Coke was able to earn $4.1 billion in a single year compared to the mere $2.2 billion it earned last year.

Keep that $4.1 billion figure in mind because it shows Coke's potential once its cash flow engine is tuned up. Coke was able to earn more than $4 billion on its current asset base while Pepsi's high-water mark is its current trailing $2.2 billion in profits.

There is no doubt that Coke needs reinvigoration, and it appears like that reinvigoration is in the works. The company's new management is quickly instituting a number of initiatives to get Coke back on top of its game.

First, Coke is quickly expanding sales of its non-carbonated drinks, a segment that is expected to go from 9% of total volume to 20%-25% over the next decade. These include everything from "energy drinks" stateside to new teas across Asia. In addition, Coke is working on improving relationships with its international partners, and the expansion potential overseas is enormous. Coca-Cola is an international powerhouse, whereas Pepsi barely registers outside North America.

Second, Coke's new management is putting a greater focus on marketing. Instead of creating all of its marketing internally at Atlanta, Coke is capitalizing on the creative and intuitive strengths of the company's local bottlers and distributors. Who better to come up with a Chinese marketing campaign than a Coke bottler in China who understands the culture and market while having a great incentive to succeed?

Since going public in 1919, Coke has hit more than a few rough patches and has come through just fine. Investors who looked at the bigger picture and held on for the long haul were rewarded more than handsomely.

I'm sure Rick will talk about the valuation discrepancy between Coke and Pepsi even though the companies had eerily similar financial results in 2000. It's an interesting point, but one needs to consider that Pepsi was in top form in 2000 while Coke was down on its luck. 2000's financial results were the exception, not the rule. When Coke's near-term problems are solved and the situation normalizes, Coke's fundamental strength will come shining through.

Paul Larson has a Coke and a smile at least once a day. You can see Paul's complete stock holdings online. The Motley Fool is investors writing for investors.

Pepsi Argument »