Dueling Fools Coke vs. Pepsi
Pepsi Argument

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Dueling Fools
By Rick Aristotle Munarriz (TMF Edible)
April 4, 2001

A pop rumble breaks out at the county fair. Coke swipes the corn dog off the stick to wield pointed wood. Pepsi peels off layers of cotton candy only to brandish a paper cone. Who wins?

Wait! It's not just a matter of splinters over paper cuts. These two brands have family at the fair who rush to their aid (or "ade" as the case might be). Sprite, Fanta, Barq's, and Surge "pop" up on Coke's side. Nestea, Minute Maid, and Fruitopia meander along.

Pepsi is not about to be outmanned here. The "fizz"-ticuffs fly. Slice lunges at Fanta. Mug and Barq's go at it. Mountain Dew and the new Sierra Mist gang up on Sprite and that Mello Yello weakling. Lipton and Nestea are squirting lemon squeezes at one another. Tropicana and Minute Maid go mano a mano.

It's a pretty intense brawl, but Pepsi's clan is just getting started. In comes Frito-Lay, the undisputed champion in snack chips with $11 billion in annual sales. Doritos, Fritos, Lay's, Cheetos, and Tostitos enter the battle come crunch time. With the pending acquisition of Quaker Oats (NYSE: OAT), Pepsi now has more than just Cap'n Crunch on board. Gatorade is making Powerade say "Uncle" while Aunt Jemima, Rice-a-Roni, and that guy on the Quaker Oats box come in for a little pure and simple pounding.

You see, the cola wars go far beyond your preference between teen pop endorsers Christina Aguilera (Coke) or Britney Spears (Pepsi). Britney wins hands down anyway. Still, it's a battle of brand behemoths. So why would anyone want to side with the number-one carbonated beverage giant when you can pick up the second-biggest player and also get the leading snack chip (Frito-Lay), juice (Tropicana), flavored rice and pasta (Rice-a-Roni), and sports drink (Gatorade) company? For a lot less?

Sure, Coke is great, but let's talk value (numbers in billions):

2000                 Coca-Cola    PepsiCo
Revenues               $20.5       $20.4
Income                  $2.2        $2.2
Free cash flow          $2.9        $2.9
Market cap            $110.5       $62.4

Pretty identical, except for the market cap. Wow, that Coke is some pricey sugar water, ain't it? If I can borrow last week's number-crunching from Matt Richey's Rule Maker piece comparing the beverage giants, we can keep going.

Rule Maker Criteria   Coca-Cola   PepsiCo
Sales growth             2.8%       12.0%
Gross margin            69.6%       61.1%
Net margin              10.6%       10.7%
Cash King Margin        14.2%       14.2%
Cash-to-debt             0.33        0.55
Foolish Flow Ratio       1.05        0.85

Let's see. Coke takes the gross margins prize but lags in everything else. And that's pretty much a given since the markup on sweetened syrup is huge. So, getting back to that market cap number, why is Coke worth 78% more than Pepsi? You can argue that some of Coke's financials last year below the sales line were part of sluggish dynamics, but isn't that enough to argue for the consistency of Pepsi? Besides, once Ali "Doritos Girl" Landry and Cap'n Crunch walk down the aisle in a Quaker wedding ceremony, Pepsi's sales will be $25 billion annually and it will still be tens of billions cheaper than Coke.

Still not convinced? What if I told you that the big turnaround for Coke this year isn't the real thing? Last week, Coke bottler Coca-Cola Enterprises (NYSE: CCE) reported that it would be missing volume and financial projections for the first quarter. As if on cue, Pepsi Bottling Group (NYSE: PBG) then came out to say that it was still on track to meet analyst expectations. Pepsi Bottling? Profitable. Coca-Cola Enterprises? It's fourth consecutive first-quarter loss.

Still think Coke is the leader? The company has already said that domestic growth will be in the 1% range but its largest bottler -- accounting for nearly three-fourths of Coke's statewide sales -- is now saying that North American unit volume will actually be coming in flat.

So as Coke is being tripped up as a one-trick pony, Pepsi continues to chug along nicely. Pepsi has been consistent. Coke has been an erratic spill. Its executives have been nothing more than a revolving door stuck in spin cycle since the passing of Roberto Goizueta.

Think about it. Pepsi will soon be putting out the San Francisco Treat -- Rice-a-Roni -- while Coke's performance has had all the twists and turns of Lombard Street. So, sure, Coke is selling more soda than Pepsi. But when you add it all up, don't you agree that it should be Pepsi, and all its parts, that is worth more than Coke? It should. But it's not. That means that Pepsi is undervalued or Coke is overvalued, or -- the more likely case -- both.

Rick Aristotle Munarriz was fueled by Pepsi One during the Duel. He also claims to have been served a Diet Pepsi at the Coke Museum coffee shop in Atlanta, but no one believes him. Rick's stock holdings can be viewed online. The Motley Fool is investors writing for investors.

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