Coke vs. Pepsi
By Paul Larson (TMF Parlay)
April 4, 2001
Rick went right where I thought he would -- stacking the two companies side by side financially and then pointing out that Pepsi trades for much less than Coke. The numbers are there, and the logic is solidly in Pepsi's favor. However, Rick is assuming that 2000 was a typical year for both companies, and 2000 was anything but typical.
To be blunt, 2000 was a terrible year for Coke.
Net profit margins were the worst they have been in 10 years at 10.6% of sales. This compares to the 15.7% average net margin it had in the last 10 years and a high of 21.9% the company achieved in 1997.
Meanwhile, Pepsi had its best year of the decade last year. Net profit margins were 10.7% last year compared to a 10-year average of 6.9%. In only three of the last 10 years has Pepsi had double-digit net margins, whereas Coke's net margins have dipped below 12% only once in this timeframe -- in 2000.
Like I said in my initial argument, 2000 was the exception and not the rule. To extrapolate this one extraordinary year -- extraordinarily good for Pepsi and extraordinarily bad for Coke -- out into infinity is, well, foolish.
Let's do a little back-of-the-envelope tinkering with the numbers. Let's assume that Pepsi, after the Quaker acquisition is completed, has $25 billion in sales and achieves a net margin of 11% (a generous profit assumption, but I digress). That will give the company net profits of $2.75 billion and a market cap, again accounting for Quaker merger, of about $76 billion. That puts the company at 27.6 times this forward estimate.
On the other hand, let's assume that Coke does $21 billion in sales this coming year and gets back to its typical profit margin of 15%. That would give the company a total profit of $3.15 billion and a current market cap of $112 billion, or 35.5 times this forward estimate.
So, yes, Coke is valued richer than Pepsi, but Pepsi's discount to Coke is not really all that great when you smooth out the statistical fluctuations in performance between the two. I would even argue the premium is warranted given Coke's enormous branding power that it can parlay into a competitive advantage.
I'm not going to knock Pepsi here. It's a good company that has done an admirable job of improving its profits over the last three years. But watch out for Coke. It's a sleeping tiger that, with a few minor adjustments, will be ready to roar once again.
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.
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