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How Sanctions Against Russia Could Hurt These Beverage Giants

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In the era of the multinational corporation, few international conflicts proceed without disrupting business for corporations headquartered all around the world. The Russia-Ukraine conflict is no exception. PepsiCo (NYSE: PEP  ) and Coca-Cola (NYSE: KO  ) are two American companies that would be affected by any business disruptions in the region, even though relatively little trade occurs between Russia and the U.S. (Russia represents less than 1% of U.S. trade.)

President Obama is threatening sanctions against Russia after Crimea voted to join Russia. Obama says the U.S. and its European allies could impose additional costs on Russia for violating Ukraine's territory. Although political rhetoric is not always backed up by action, U.S.-Russia relations are clearly headed downhill. If Russia were to retaliate with anti-Western sanctions, PepsiCo and Coca-Cola could be banned from doing business in the country. As a result, it is important for investors to understand the impact that may have on these companies' valuations.

PepsiCo and Coca-Cola in Russia
Back in the late 1950s, when PepsiCo was getting its rear end handed to it by Coca-Cola in the U.S., the No. 2 soft drink company took a risk and entered the Russian market. For decades, Pepsi was the only Western soft drink in Russia, allowing it to gain an insurmountable foothold in the country. Now, PepsiCo derives more than 7% of its revenue and has nearly 15% of its long-lived assets in Russia; PepsiCo's Russian presence is second only to that in the U.S.

Moreover, PepsiCo has made significant investments in Russia in recent years. It recently paid $5.2 billion to acquire Russia's largest dairy producer and another $2 billion to acquire a Russian juice company. Given that PepsiCo's long-lived assets total only $53 billion, the company's Russian investments are significant compared to the company's overall size.

Coca-Cola, on the other hand, has a relatively small presence in Russia. Russians consumed 79 eight-fluid-ounce servings per capita of Coca-Cola beverages in 2012, less than the world average and about 1.6% of Coca-Cola's total beverage volume. With its Russian volumes growing at a low-single-digit annual rate, Russia is unlikely to ever become a significant contributor to Coca-Cola's bottom line.

Gauging the impact
The impact on Coca-Cola is clear: Russia could nationalize all foreign assets and Coca-Cola's valuation would hardly be affected. The company's late entry into the country has prohibited it from building a meaningful presence, shielding it from the current international dispute.

On the other hand, PepsiCo has a lot to lose. If Western nations impose economic sanctions on the country, Russia may retaliate with sanctions of its own. PepsiCo could be barred from doing business in the country, causing 7% of its revenue and 15% of its long-lived assets to evaporate overnight.

But the situation may de-escalate in the coming weeks. As The Wall Street Journal reports, freezing Russian assets in Germany and Great Britain will hurt the Russian economy, but cutting off Russian gas to Europe will hurt the European economies. As a result, both sides of the dispute are incentivized to come to a peaceful resolution.

Unfortunately, an armed conflict between Russia and Ukraine is still a real possibility. An outright war -- or even the prospect of war -- would likely send the Russian ruble crashing. As a result, PepsiCo would sustain heavy currency losses on 7% of its revenue base. But as with sanctions, the effect would likely only be temporary. As a result, shareholders need not worry about significant value impairment.

Bottom line
Nobody can predict world-changing events ahead of time -- they just happen. Regardless of what happens in Russia, shareholders who own great businesses will do well over the long run. Great businesses sometimes have bad years, but they always pull through and continue to compound shareholder capital at a high rate of return. By all accounts, Coca-Cola and PepsiCo are among the greatest businesses on earth. Shareholders can rest easy knowing that both will be worth far more in 10 years than they are worth today, no matter what happens tomorrow.

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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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9/1/2015 4:00 PM
KO $38.75 Down -0.57 -1.45%
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