1 Little-Known Attribute Could Be Key to Restarting Growth at Coca-Cola and PepsiCo

During last Monday's interview with CNBC, Warren Buffett said something interesting about soft drinks. The famous Coca-Cola (NYSE: KO  ) shareholder and PepsiCo (NYSE: PEP  ) admirer told CNBC's Becky Quick, "The interesting thing is that diet soft drinks have actually gone down more in this country than the sugar drinks, which you wouldn't think would be the case, by which your..."

Quick cut him off, but Buffett was saying that, if consumers' health concerns were driving declining soft-drink volumes, one would expect sugary beverages to fall out of favor at a faster pace than diet drinks. Buffett went on to remind us that "close to a quarter of all liquids consumed in the United States are carbonated soft drinks." Clearly, the Oracle of Omaha is still bullish on soft drinks -- and is skeptical that health concerns are dragging down the industry.

Maybe it isn't the sugar after all
The great news is that there is evidence to support Buffett's intuition. While Coca-Cola and PepsiCo duke it out in the cola wars, flavored soft drinks are increasingly gaining favor among consumers. PepsiCo's Mountain Dew Kickstart -- an all-in-one flavored carbonated beverage, energy drink, and breakfast drink -- is one of PepsiCo's most successful product innovations in recent years.

Together with Gatorade Frost Glacier Cherry, Starbucks Iced Coffee, and Lipton Pure Leaf, Mountain Dew Kickstart is expected to reach $100 million in annual sales in North America. Though only a fraction of PepsiCo's $21 billion in sales in the Americas, the group's initial success is indicative of consumers' changing desires.

Although soft drinks' negative health effects are getting all of the press coverage, purchasing trends suggest that consumers are just looking for new and bold flavors. According to industry consultant Mary Pellettieri, "people still desire carbonation, but they're tired of diet and cola."

The Coca-Cola Company

That's why Mountain Dew Kickstart has been such a hit and why Coca-Cola is launching new innovations like Diet Coke Frost, a cherry-flavored, low-calorie frozen extension to its Diet Coke brand.

In the context of consumers' desire for bigger and better taste, it makes sense that diet colas are declining at a steeper rate than the broader category. Diet colas use artificial sweeteners -- instead of the high-fructose corn syrup used in regular cola -- which tend to have a bitter aftertaste.

Moreover, health-conscious consumers are the natural constituents for diet drinks; but now that a link has been established between artificial sweeteners and a variety of health issues, the group is fleeing the category.

Instead, health-conscious consumers may be drinking more bottled water, tea, or coffee. It is important to remember that while consumers may flee one beverage category, they almost always go to another. People are not drinking fewer beverages. They are just changing the beverages they drink. As two of the largest beverage companies in the United States, Coca-Cola and PepsiCo have the distribution and innovative wherewithal to recapture lost customers by expanding their product portfolios.

Traditional soft-drink flavors not dead yet
Coca-Cola is not giving up on its flagship product just yet. According to a Coca-Cola executive, a shocking number of 18-24 year-olds have not yet tried Coke. To counter this, Coca-Cola is rolling out a nationwide sampling campaign to introduce a new generation to Coke Classic. The company is also experimenting with different packaging, such as chill-activated cans and new package sizes. It hopes that the efforts will generate buzz around its classic line-up of soft drinks.

Moreover, Coca-Cola's partnership with Green Mountain Coffee Roasters gives it a new distribution channel and one that could recapture consumer interest in carbonated beverages. Wells Fargo beverage analyst Bonnie Herzog calls the partnership a "bold and exciting move" that could "reignite [carbonated soft drink] volumes as it creates new consumption occasions."

However, with the launch of Keurig Cold a year away, the at-home carbonation channel is still unproven.

For now, energy drinks continue to usurp market share from soft drinks. Even in this surging category -- energy drink volumes grew 7.4% in the convenience-store channel last year -- new and bold flavors are driving growth. Market leaders Red Bull and Monster Beverage have come out with line extensions like Red Bull Total Zero and Muscle Monster protein shake. No matter what the category, new and exciting beverages are what attract consumers.

Foolish takeaway
Total beverage consumption is more likely to increase than decrease in the coming years. The good news is that consumers may be willing to drink unhealthy sugary beverages. The bad news is that, as consumers demand new and interesting concoctions, Coca-Cola and PepsiCo need to go into innovation overdrive to keep up with the competition. There is no telling which new products will catch on, but few other companies have the distribution and marketing might of a Coca-Cola or PepsiCo. As a result, it will be tough to bet against either company in the years ahead.

Investors who buy Coca-Cola or PepsiCo will do well in the years ahead. However, one stock will make you filthy rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

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Ted Cooper

Ted Cooper is a value investor based in Texas. He does not ride a horse to work.

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