Investing in Global Soft Drink Players: PepsiCo vs Coca-Cola

Coca-Cola experienced slower growth in the past year, but that was temporary. PepsiCo, on the other hand, could enhance shareholders' value with the recent partnership with Buffalo Wild Wings and a potential business breakup.

Jan 5, 2014 at 6:59AM

Coca-Cola (NYSE:KO), the global leader in the soft drink market, did not provide its shareholders a good enough return in 2013. It returned only around 14%, much lower than the stock price performance of PepsiCo (NYSE:PEP), which gained around 21.20%. However, both companies trailed the S&P 500's gain of 29.60% during the same period. While Coca-Cola could deliver better returns by reducing manufacturing and logistics costs and boosting revenue, PepsiCo could enhance its shareholders' value by splitting its beverage business from its food business. In fact, activist investor Nelson Peltz has suggested that PepsiCo merge its food business with global snack giant Mondelez International (NASDAQ:MDLZ).

Slower growth is temporary for Coca-Cola
According to Barron's, Coca-Cola has been famous for consistently generating 3%-4% volume growth and high-single digit EPS growth. In the past three quarters, however, its volume increased by only 2% and its EPS, excluding one-time items, experienced only a 4% rise. In recent years, Coca-Cola has faced increasing health awareness that has made consumers stay away from carbonated drinks. As a result, the company has turned its focus on emerging market growth potential and diversified into healthier beverages.

In the third quarter, however, Coca-Cola managed to deliver a comparable currency neutral net revenue growth of 4% and operating income growth of 8%. The company believes that in a challenging global economic environment, it will keep improving its operating performance by taking a disciplined approach to its diversified portfolio and reinvesting its savings to expand on its global geographic reach. It's very hard for any company to beat Coca-Cola because of its well-established global distribution network. The total number of servings sold by the company reached 181 billion in the third quarter. 

Despite short-term challenges in emerging markets, there are tremendous growth opportunities there for Coca-Cola in a long run. These include urbanization trends, a rising middle class, and growing disposable income. Apart from the classic Coca-Cola brand, the company also holds solid leading positions in the sparkling beverages, juice and juice drinks, and waters category. By 2020, Coca-Cola expects to double its 2010 system revenue and simultaneously improve system operating margins. The cumulative cash flow is estimated to reach $130-$150 billion, $35 billion of which would be used to reinvest into the company. 

When the snack business provides significant advantages to the beverage business
PepsiCo, the second biggest soft drink player worldwide, has generated most of its operating profit from its snack business. Nelson Peltz has called for the separation of PepsiCo's beverage business and its snack business, merging the snack business with Mondelez. Mondelez has leading positions in several snack categories, including biscuits, candy, and chocolate. He believes that the two companies could realize around $3 billion in revenue synergies and another $3 billion in cost synergies, as well as margin improvement for Mondelez. Moreover, the merger of the two businesses could create an emerging market snack powerhouse, owning the most valuable brand portfolios in the world. 

However, PepsiCo's snack business could significantly support its beverage business. Recently, Buffalo Wild Wings, a big chicken wings restaurant chain, switched its soft drink offerings from Coca-Cola to PepsiCo as it plans to offer a new menu that includes PepsiCo's Doritos. This strategic move might take its cue from Taco Bell's recent success with Doritos Locos Tacos, which have delivered more than $1 billion in sales. 

My Foolish take
Both Coca-Cola and PepsiCo offer their shareholders decent dividend yields at 2.80% and 2.70%, respectively. With an EBITDA multiple of 12.1, PepsiCo is a bit cheaper than Coca-Cola, which is valued at nearly 15 times EV/EBITDA. The partnership with Buffalo Wild Wings will also improve PepsiCo's operating performance in the near future. While both Coca-Cola and PepsiCo could fit well into the long-term portfolios of income investors, I still prefer PepsiCo because it is cheaper and has more potential to enhance shareholder value in the future. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of Coca-Cola and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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