PepsiCo Is Still Your Best Beverage Investment

Despite the uproar of Trian Partners, PepsiCo is still a better investment than Coca-Cola for the long run.

Jun 17, 2014 at 10:00AM

PepsiCo (NYSE:PEP) is still under attack from Trian Partners. The activist hedge fund owns around $1.2 billion of PepsiCo. The hedge fund has described the company as a "culture of sycophants" and promised that reform would come. During its many years of activism, it's uncommon for Trian not to find common ground with management. Trian wants the company to split its snack and beverage business; however, its the combination of these two businesses gives PepsiCo distinct advantages over top rival Coca-Cola (NYSE:KO).

Trian's main pain points
Trian has stated that PepsiCo and CEO Indra Nooyi "made a major mistake" and "built this huge corporate bureaucracy," which was a major reason the company had underperformed in recent times. Trian is insisting that, among other things, the beverage and snack business should be separated.

The Pepsi Spire initiative
PepsiCo is also taking Coca-Cola head on in the beverage space. PepsiCo recently rolled out its fountain dispenser, Spire. The machine allows customers to create more than 1,000 personalized beverages at the touch of a finger. This is a key move as soda sales in grocery stores and other outlets have been in decline. PepsiCo's Spire is the company's response to Coca-Cola's Freestyle machines. These new dispensers allow beverage companies to engage with their customers. 

Coca-Cola dominates the fountain business and, according to some analysts, has a market share of around 70% in places like movie theaters and retail outlets. There are 20,000 Freestyle machines spread across the country at various restaurant chains including McDonald's (NYSE:MCD), which is a major reason for Coke's dominance in the fountain business. McDonald's has more than 35,000 stores worldwide, which gives Coca-Cola impressive exposure. With Spire, PepsiCo is looking to fight back.

Stacking up the beverage giants
PepsiCo reported 7% year-over-year growth in earnings for the first quarter, coming in at $0.83 a share. It's targeting earnings to grow at a similar rate for the entire year. Meanwhile, top competitor Coca-Cola is expected to post earnings for the full year of 2014 of $2.08 per share. This would imply no growth over 2013.

Both companies are being faced with the problem of a decline in Americans consuming carbonated beverages. PepsiCo is partly protected against this trend because snacks account for more than 50% of its revenue. Frito-Lay North America and PepsiCo Americas Food reported revenue growth of 4% and 5%, respectively. Both companies showed revenue growth in emerging markets (such as Brazil and China), which are vital for their long-term prospects.

What makes PepsiCo great?
PepsiCo has 22 brands, where each generates more than $1 billion in sales each year. About 50% of its revenue is generated from international sales. That's a positive, considering soda sales in the U.S. have been flat.

A couple of PepsiCo's main catalysts for growth is its snack brands and increasing share in emerging markets. Reasons PepsiCo plans to keep its beverage and snacks businesses intact are the added benefits related to marketing and increased negotiating power with retail stores. A focus for PepsiCo will be continued innovation, which includes new products. A few of its newest inventions include Mountain Dew KickStart, Starbucks Iced Coffee, and Tostitos Cantina chips.

How shares stack up
PepsiCo trades at a P/E ratio of 17.8 based on next year's earnings estimates. Its dividend yield is a healthy 3.1%. Coca-Cola trades at a forward P/E ratio of 18.2, and its dividend yield is 3%. PepsiCo trades just below Coca-Cola on a P/E basis, but given its strong snacks business, the case could be made that PepsiCo deserve to trade at a premium valuation.

The dividend payments for both the beverage companies have been on the rise for several decades. PepsiCo has increased its annual dividend payment every year for 41 years, and Coca-Cola clocks in at 51 years. Meanwhile, McDonald's also has a strong dividend, yielding 3.2%, and the payment has been increased for 37 consecutive years.

Bottom line
PepsiCo and Coca-Cola are two of the purest plays on the beverage industry. They both have a broad geographical reach and pay investors a healthy dividend. PepsiCo's snacks business gives it a leg up with customers. For investors looking to gain exposure to the beverage industry, PepsiCo is worth a closer look.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, McDonald's, and PepsiCo. The Motley Fool owns shares of 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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Keeping it simple.

Aug 7, 2015 at 11:26AM

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