The war against Coca-Cola (NYSE: KO ) , PepsiCo (NYSE: PEP ) , and other soft drink companies is starting to look a lot like the war against Philip Morris (now Altria Group (NYSE: MO ) ) and Big Tobacco.
Study after study comes out warning about the health risks posed by soft drinks, but Big Soda is fighting back. The American Heart Association published an abstract of a study that links sugar-sweetened beverages to 180,000 deaths worldwide each year. The American Beverage Association fiercely contested the study, arguing that the abstract "is not peer-reviewed nor published in any way where its methodology can be fully evaluated. [It] is more about sensationalism than science."
Coca-Cola and PepsiCo face Philip Morris-like tax
No matter which side is correct -- and both sides are probably overstating their respective cases -- public sentiment is clearly turning against Coca-Cola and PepsiCo. According to a 2011 article in Time magazine, "nearly 20 states and cities are now considering soda taxes, and a long list of international health organizations have called for reduced soda consumption."
A recent proposal for a soda tax in San Francisco seems eerily similar to taxes levied against Philip Morris. The proposal calls for an $0.02 per ounce tax on sugary beverages -- essentially an $0.24 tax on the typical 12-ounce soda can. The tax would reduce soda consumption and fund public awareness campaigns to encourage healthier behavior.
The tobacco tax works in the same way, with proceeds from the tax going to fund anti-smoking campaigns and other government programs. It seems as though all levels of government have become addicted to raising excise taxes. According to Philip Morris, 55% of the sales price of a pack of Marlboro cigarettes goes into the pockets of federal, state, and local governments. A decade or two from now, the same tax may be due on a can of Coca-Cola.
Philip Morris diversified like PepsiCo, then undiversified like Coca-Cola
Amid a growing list of states adding excise taxes on tobacco, Philip Morris began to diversify its operations through a string of acquisitions. In the 1980s, it acquired two companies that eventually became Kraft Foods. Altria, Philip Morris USA's parent company, has since spun off the Kraft Foods unit and again almost completely relies on the tobacco industry.
PepsiCo is in a position similar to that of Philip Morris in the 80's and 90's. The company has the second-largest share of the much-maligned soft drink market, behind only Coca-Cola. However, PepsiCo also owns Frito-Lay, the largest salty snacks company in the world. According to Morningstar, Frito Lay has a 40% share of the global salty snacks market; it is essentially the Coca-Cola of snack foods. This provides PepsiCo with a wide-moat company that makes it less dependent on the uncertain soft drink industry -- not unlike Philip Morris's diversification with Kraft.
Coca-Cola, on the other hand, is completely at the mercy of sugary beverages. Even so, international unit case volume represented 81% of Coca-Cola's total unit case volume in 2012. The company's geographic diversification buys it some time because rhetoric against soft drinks is most heated in the United States. However, if the current direction of worldwide public opinion persists, Coca-Cola's core offering will soon be slapped with burdensome excise taxes.
Not all is lost, however, even if Coca-Cola refuses to expedite the diversification of its offering into healthier beverages. After spinning off its food division, Altria again relies on a hated product -- tobacco -- and it is as profitable as ever. Despite the harsh laws and regulation in the industry, Altria's market position enables it to earn a high-30s operating margin and a mid-to-high-teens return on invested capital, according to Morningstar data. The same could be true for Coca-Cola; the world market leader is in a much better position to handle burdensome taxation than its smaller competitors, possibly leading to increased market share and maintaining its profitability.
Changes are coming in the soft drink industry and they look a lot like the changes made to the tobacco industry many decades ago. The changes will hurt the soft drink industry overall -- and Coca-Cola would be wise to continue diversifying its line-up of drinks into healthier options -- but Altria's success in a heavily taxed industry suggests that Coca-Cola may not be in a such terrible position after all.
Diversify your portfolio with dividend stalwarts
If you're looking for some long-term investing ideas, you're invited to check out The Motley Fool's brand-new special report, "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so simply click here now and get your copy today.