Which of the Big 3 Beverage Giants Presents the Most Upside?

Dr Pepper Snapple, PepsiCo, and Coca-Cola all have their fair share of problems, but which, if any, are presenting the greatest investment value going forward?

Feb 14, 2014 at 5:30PM

Dr Pepper Snapple Group (NYSE:DPS) reached new all-time highs on Wednesday, as the market apparently liked what it heard out of earnings. However, given its report and valuation, is it a better investment than peers Coca-Cola (NYSE:KO) or PepsiCo (NYSE:PEP)?

Problems plaguing the soft-drink industry
Dr Pepper Snapple is a $10 billion company whose products are fairly well saturated into the market. Therefore, investors don't really expect periods of strong growth, as they understand that fundamental performance is more a result of macro demand for carbonated drinks and juices.

The problem for Dr Pepper and peers Coca-Cola and PepsiCo in the last couple years is that sales of carbonated drinks and juices are falling in volume as consumers in the largest market, the U.S., elect to drink healthier beverages such as bottled water, or those artificially flavored.

This macro shift was highlighted last year in Credit Suisse's "Sugar: Consumption at a Crossroads" report, which looked at the negative medical, economic, and consumer impact of sugar consumption; also calling sugar the new tobacco. As a result, this brought a lot of negative attention to the soft-drink industry with additional reports from ABC, CNBC, and Forbes among others, with the latter estimating that $1 trillion in U.S. health-care spending can be linked to sugar.

Hence, it has been a rough year for the soft-drink juggernauts, and despite Dr Pepper reaching all-time highs on Wednesday, these problems were even more evident in the company's fourth-quarter report.

How are the companies performing?
While Dr Pepper did show a significant improvement to its bottom line, caused by a 5% decline in selling, general, and administrative expenses, sales were once more weak. In particular, sales volume declined a rather large 4%, but the company's fundamentals were in large part aided by strong pricing, which translated to total revenue losses of just 1.4%.

Still, a 4% decline in sales volume is significant and is a familiar tune of what we've seen throughout the industry.

In Coca-Cola's last quarter its global case volume increased just 2%, which was mainly driven by emerging markets. However, Coca-Cola has had to become more aggressive with pricing, thus total revenue declined 2.5%.

Then, there is PepsiCo, a company that reported earnings on Thursday and is considered by many to be the strength of the space. Its beverage unit saw a 1% increase in organic volume, but its growing snacks division was the company's strongest performer, which increased 3%. Hence, PepsiCo's snacks business becomes a bit of a hedge against the weakness in soft drinks, which is something neither Coca-Cola nor Dr Pepper offer.

Is there any value?
For 2014, all of the three companies discussed are expected to produce year-over-year growth. However, it's worth noting that the only reason for this growth is because it will be compared to 2013, which consisted of fundamental declines.

The only exception is PepsiCo, which not only grew nearly 2% in 2013 but is expected to grow an industry-best 3.8% this year. With that said, these companies all trade at similar multiples.

Company

Forward P/E Ratio

Coca-Cola

17.43

PepsiCo

17.38

Dr Pepper

15.24

Dr Pepper is the only one of these three companies that trades at a considerable discount to its peers, which is likely due to its fundamental weakness, or volume declines.

With that said, PepsiCo is clearly the best fundamental performer of the three, and not because Pepsi is better than Coke but rather due to its snack segment. Hence, PepsiCo is well-deserving of a valuation premium, yet it does not exist.

Final thoughts
As an investor, if you find yourself compelled to hold one of these three stocks in your portfolio, then PepsiCo looks to be your best bet.

Ironically, PepsiCo is currently trading lower by nearly 3% after earnings, as investors show their dissatisfaction of the company not splitting its snacks and beverages business into two companies. Yet as previously stated, the snacks business is a good hedge against soft-drink weakness, and for this reason, PepsiCo might very well outperform its peers long term.

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Brian Nichols 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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