Packaged-beverage rivals Coca-Cola (NYSE: KO ) and PepsiCo (NYSE: PEP ) should split up.
Not with each other, of course, but with their troubled North American operations.
A shareholder-friendly portfolio play
That's right -- both companies should spin off their sluggish North American beverage businesses as separate entities.
Currently, shares of both names suffer a conglomerate discount -- the inevitable result of geographic footprints that span both high-growth international markets and a long-dreary domestic landscape.
Look, this notion isn't as crazy as it might sound. By taking over key North American bottlers, both companies have already copped to major North American challenges. I'm merely suggesting that they go whole hog.
For an example of a similar move in the consumer packaged-goods industry, look no farther than Altria's (NYSE: MO ) 2008 spinoff of its international tobacco business. As Altria management explained the restructuring:
Some of the benefits include an improved focus on the different market dynamics and competitive frameworks, a more optimal and efficient capital allocation, a greater financial flexibility, a greater transparency leading to the elimination of the sum-of-the-parts discount under which Altria's stock has typically traded ...
Notwithstanding differences between the cigarette and soda markets, I think you could easily cut and paste that same reasoning into a Coca-Cola or PepsiCo press release.
Of course, you want to know how Altria investors have fared, right? Since receiving Philip Morris International (NYSE: PM ) shares on a one-for-one basis in March 2008, Altria stock is down close to 10%. PMI shares, however, are roughly flat. Moreover, PMI trades at a forward P/E of 12.1, versus 10.3 for its former parent. One thing is clear: The market has indeed acknowledged the comparative strength of international operations, delivering shareholders a better return and higher multiple on that business.
I believe that a similar scenario would unfold for Coca-Cola and PepsiCo. But in this case, I expect that shares of the international entities would outperform on both a relative and absolute basis, producing a net shareholder return above recent levels.
Before we take this argument any further, let's drill down on recent segment results.
The numbers tell the story
Below, I've highlighted the 2009-2008-percentage change in Coca-Cola's key performance metrics, segmented by operating division:
|
Division
|
Volume
|
Revenue
|
Operating Profit
|
Currency-Neutral Operating Profit
|
|
Eurasia & Africa
|
4%
|
(6%)
|
(3%)
|
12%
|
|
Europe
|
(1%)
|
(10%)
|
(7%)
|
4%
|
|
Latin America
|
6%
|
1%
|
(3%)
|
15%
|
|
North America
|
(2%)
|
0
|
7%
|
7%
|
|
Pacific
|
7%
|
4%
|
2%
|
(2%)
|
|
Bottling Investments *
|
2%
|
(7%)
|
(32%)
|
23%
|
Data from company Q409 release.
* Bottling Investments not segmented by geography.
Based on revenue and operating profit, international operations actually underperformed the domestic unit. But that was largely due to currency movements, and there's no guarantee that the dollar can maintain its relative strength in the long term.
Furthermore, volume measures underlying performance at the consumer level; here, North America is clearly the weakest link. The story was similar in 2008, when North American volume slipped 1% versus an all-segment volume gain of 5%.
The picture doesn't brighten for PepsiCo, either. Because the company's portfolio comprises both snacks and beverages, I've restricted volume figures in the list below to beverage-only results. Other metrics, however, are necessarily food-and-beverage inclusive.
Once again, stated figures indicate 2009-2008 percentage change.
|
Division
|
Volume
|
Revenue
|
Core Operating Profit **
|
Currency-Neutral Core Operating Profit
|
|
Americas Beverages *
|
(6%)
|
(8%)
|
(5.5%)
|
(3%)
|
|
Europe
|
3.5%
|
(2%)
|
(3%)
|
13%
|
|
Middle East, Africa, & Asia
|
8%
|
9%
|
20%
|
23%
|
Data from company Q409 release.
*Americas Beverages includes North and South America.
**Non-GAAP measure that adjusts for restructuring and merger-related activities.
Unfortunately, PepsiCo aggregates North and South America results (a bit of smokescreen, perhaps?) into "Americas Beverages," but as I've previously demonstrated, it's likely that the cash-strapped and soda-weary U.S. consumer drove the volume decline.
Importantly, investors should understand that industrywide U.S. carbonated beverage volume, while no doubt pressured by the Great Recession, turned negative as early as 2005. Moreover, ample evidence suggests that U.S. consumers may not return to their old habits once Main St. headwinds ease. In other words, the corporate break-up argument in no way relies solely on 2008-09 macro events.
With that point made, let's take a look at how the stocks of international and domestic entities would likely trade.
Growth stock, meet "utility stock"
The North American beverage business itself diverges across "still" and carbonated products. In Coca-Cola's 2009 results, North American carbonated beverage volume declined 3%, while still beverage volume grew 1%, helped by brands such as Fuze and Simply.
So in terms of a stand-alone North American company, the market would be watching closely to see whether Coca-Cola or PepsiCo could ramp up still beverage volume to fully offset soda's flat performance.
Such an accomplishment, however, would likely be a ways off, and I don't expect that the market would grace shares with the benefit of the doubt. Accordingly, I believe that investors would initially view such a stock like a low-to-no growth utility. A juicy dividend, supported by, say, a 60%-70% payout ratio, would no doubt attract income-seeking investors who accept that significant capital appreciation may or may not be in the cards, depending on core business results.
All told, shares could trade along the lines of a Reynolds American (NYSE: RAI ) or even an AT&T (NYSE: T ) or Verizon (NYSE: VZ ) , where a 6%-ish dividend yield supports the stock of a company whose growth is clearly in question.
At the opposite end of the spectrum, I expect that shares of the liberated international companies would race ahead of Coca-Cola and PepsiCo's current forward P/E's in the 13-15 range, perhaps scoring a multiple in the high teens, depending on the performance and outlook for key consumer markets such as Latin America and China.
Investors, finally, could get excited about international growth prospects without the caveats, euphemisms, and doublespeak that currently pervade company reports and conference calls.
I don’t know about you, but I'd definitely drink to that.
Am I off my rocker, or does a North American spinoff make sense for both Coca-Cola and PepsiCo? Voice your take in the comments section below!
Do you like income-producing consumer stocks? Jim Royal thinks they're one of the safest investments around.
RSS Headlines
Fool UK