Restaurant chain Buffalo Wild Wings (NASDAQ: BWLD ) recently announced its decision to switch from Coca-Cola (NYSE: KO ) products to PepsiCo (NYSE: PEP ) . While it may not seem like the end of the world for Coke to lose the business from Buffalo Wild Wings and its 975 or so locations, it could indeed be a big deal if this turns out to be part of a larger trend. Let's see how dependent these two beverage and snack giants are on their restaurant business and which direction the wind might be blowing in.
PepsiCo, Coca-Cola, and their fountain drink business
Between the two companies, Pepsi and Coke dominate the U.S. fountain drink business, with Coke leading the market with a share of about 70%. So how important are fountain soft drink accounts to these companies' bottom lines?
The short answer is that fountain sales are extremely important. Fountain sales account for just over one-quarter of all soft drink sales in the U.S. Coca-Cola's sales totaled just over $48 billion last year, 45% of which was from North America. If one-fourth of those were fountain sales, that means that North American fountain sales alone accounted for about $5.8 billion of Coca-Cola's sales last year. A similar calculation for Pepsi reveals about the same amount.
Recent switches and other factors to consider
As far as Buffalo Wild Wings is concerned, one of the most significant things mentioned in its announcement is its plan to also incorporate PepsiCo's non-beverage products into menu offerings. In addition to the beverages for which it is best known, Pepsi produces such snack foods as Doritos, Cheetos, Lays, Ruffles, and Sun Chips. It also produces the Quaker line of hot cereals and oat-related foods.
These are some popular snack brands, and could very well be a deciding factor in companies switching alliances. Additionally, Pepsi products are generally cheaper than Coke, meaning they carry potentially higher profit margins for businesses, which has been cited as a reason for several switches.
As far as recent history goes, there have been a few major switches in both directions. Earlier this year, for example, Costco replaced Coke products with Pepsi in its food courts, a movie that was met with mixed reactions from customers. IHOP restaurants also switched to Pepsi within the past few years, as did Papa John's.
In the other direction, Coca-Cola has also taken steps to offer better products in order to keep its dominant fountain drink market share. The company developed a 120-drink computerized drink fountain that uses micro-dosing technology (similar to the type used by drug companies) in order to offer customers an unmatched variety in fountain beverages. Some of Coca-Cola's customers have embraced the new systems, including White Castle, which is using the new drink fountains as an example of its willingness to adopt new innovations.
Large chains switching to Coke have been rare, however. The only large company to dump Pepsi for Coke is Dunkin' Brands, which ended its partnership with Pepsi in 2012.
What it means to you as an investor
While Coke still has some of the largest fountain accounts in the market, including fast-food giant McDonald's, the trend seems to be going in the other direction. More competitive pricing and a wider variety of food items that can be integrated into menus are both positive catalysts for Pepsi.
As far as the investability of the two companies is concerned, let's see if one is cheaper than the other and if the slow increase in Pepsi's fountain business creates an opportunity.
Pepsi currently trades for 18.6 times the $4.34 per share in earnings that it is expected to report this year. This is expected to rise to $4.71 and $5.09 over the next two years, for average annual earnings growth of about 8.3% annually. However, keep in mind that if the Coke-to-Pepsi transition continues, the earnings growth should be significantly better. Pepsi also pays a 2.8% annual dividend, and has raised its dividend consistently in the past.
Coke is similarly valued at 18.8 times this year's earnings, which is expected to grow at a slightly lower 7.4% annual rate. The dividend yield is also very similar to Pepsi's.
So, even though Pepsi has significant growth potential due to its fountain drink business and variety of nonbeverage products, shares are valued more cheaply than Coke's. If you agree that the trend of restaurants switching to Pepsi will continue, Pepsi may be an excellent fit for your portfolio.
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