One Cola Company With an Edge

PepsiCo's fast-growing food business offsets sluggish soda sales as pure play Coca-Cola faces a stagnant market.

May 6, 2014 at 6:30PM

The cola battle has raged on for years. As a result, Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP) are always coming up with new products to win the hearts and minds of consumers in a competitive marketplace.

However, PepsiCo's intriguing strategy should allow shareholders to experience faster growth than with its pure beverage competitor.

Proof in the pudding
PepsiCo has moved beyond just providing soda. It has an attractive foods business that provides snacks and breakfast goods with a stable of well-established brands such as Frito Lay and Doritos. In fact, this part of the business is growing faster than the beverage portion, which has grown a bit stale.

PepsiCo's latest results demonstrate the benefits of having a strong foods group. The PepsiCo Americas Foods business unit includes Frito-Lay North America, Quaker Foods North America, and the Latin America food and snack segments. The entire unit had a very respectable 5% rise in organic revenue (organic results strip out the affects of acquisitions, divestitures, and currency translations). The revenue rise helped lead to an equal increase in the unit's core operating profit when measured on a constant currency basis.

Meanwhile, soda consumption has taken a hit in the United States. This can be observed through the company's PepsiCo Americas Beverages segment, which includes Latin America. Organic volume was flat, and its core operating profit was down 3%.

It becomes evident when examining the entire company's results that the foods business is its main strength. Despite weakness in the PepsiCo Americas Beverages segment, generally accepted accounting principles earnings were $0.79 a share for the first quarter, up more than 14% from a year ago.

Coca-Cola, the largest beverage company in the world, is feeling the effects of declining soda consumption, despite attempts to diversify its offerings with brands such as Minute Maid, Powerade, and Dasani.

Although its case volume grew 2% in the first quarter, results were flat in North America. Revenue for the entire company was down 4% year over year, to $10.6 billion. Furthermore, despite a 1.4% reduction in the share count, diluted earnings per share were down 6% to $0.36.

An activist in the midst
Activist investor Nelson Peltz, through his Trian Fund Management investment vehicle, owned 12.3 million shares at year-end, which equates to less than 1% of the shares outstanding. Nonetheless, Peltz has been trying to get the company to spin off its beverage business, with his latest efforts coming earlier this year. He hopes two separate companies would trade with higher valuations than a single company. In theory, the snacks business would be able to grow faster without having the anchor of the more sluggish but stable beverage business.

Management rejected the proposal, stating the two portions integrated as one company maximize value for shareholders. Among other things, management pointed out that this helps it to negotiate with retailers.

Activists have been criticized for attempting to maximize value in the short run. A spinoff would undoubtedly cause an immediate bump in the stock price. However, whether it can be sustained is another question; although in this case it makes a certain amount of sense. In any case, Peltz will need other investors to jump on the bandwagon.

Final thoughts
PepsiCo's shares are not cheap, trading with a trailing P/E of 19 times. Still, its snacks business provides nice growth to offset the more sluggish beverages. The company is also committed to returning cash to shareholders--it expects to spend $5 billion on share buybacks and another $3.7 billion for dividends.

In fact, shareholders will appreciate the predictable and steadily rising dividends. The quarterly rate has gone from $0.14 a share in the year 2000 to the current $0.5675. PepsiCo even raised its payout throughout the lean economic times during the Great Recession.  

If Peltz gets his way, there might be two separate companies. One would provide a nice payout alongside one that has faster growth. In the meantime, these results are likely to continue pleasing shareholders.

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Lawrence Rothman 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 and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. 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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