A Key Test Is Coming for Coke and Pepsi. Here's What You Need to Know

Here's why 2015 could be a make-or-break year for Coca-Cola and PepsiCo.

Jul 16, 2014 at 6:00PM

Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP) are known to have strong beverage franchises that carry significant pricing power. In theory, pricing power should shield them from competitive threats -- and even mitigate losses from industrywide declines in demand. Both companies have taken advantage of their pricing power, but neither has been able to completely offset beverage volume declines.

The next year will be a crucial test for both companies' beverage businesses. Keurig Green Mountain (NASDAQ:GMCR) could play a key role in it. If the channel innovations and new product introductions of Coca-Cola and PepsiCo do not lead to higher growth in 2015, investors may rightly doubt the beverage giants' durability. Here's what needs to happen for the two companies to pull it off.

New channels to reignite consumer interest
Coca-Cola and PepsiCo are branching into new distribution channels to reignite consumer interest in their beverages -- particularly soft drinks. Coca-Cola has already partnered with Keurig on the coffee company's newest innovation, Keurig Cold. Keurig Cold is due out in Keurig's fiscal 2015, which starts in October. The at-home carbonation system could claw back ex-soda drinkers who previously left the category for alternative beverages. If that happens, both Coca-Cola and Keurig would benefit tremendously.

Spire

Pepsi Spire is PepsiCo's answer to Coca-Cola's Freestyle.

PepsiCo may also benefit from Keurig Cold's success. The No. 2 soft drink company already serves the at-home carbonation market through its partnership with Bevyz, but CEO Indra Nooyi is open to the possibility of a partnership with Keurig. Nooyi says that PepsiCo is working with multiple platforms, telling investors that she's "making sure that we don't lock and load with any technology until the technology has proven out." My bet is that Nooyi waits until Keurig Cold's final design has been tested and manufactured before hitching PepsiCo to the platform.

In addition, PepsiCo recently announced Pepsi Spire, a new soda fountain that can be placed in restaurant chains and can compete with Coca-Cola's Freestyle. This could further boost buzz in the beverage world -- something that benefits both Coca-Cola and PepsiCo.

However, if Keurig Cold and other channel innovations do not lift soft drink sales in 2015, perhaps nothing ever will. That would warn investors that a long-term secular decline in soft drinks is under way.

New products are generating buzz
Although delivering beverages in new and interesting ways could reignite consumer interest in soft drinks, bringing new products to the market that suit consumers' preferences will produce larger long-term benefits.

Ko Life

Coke Life could put some life back into soft drink sales.

Later this year, Coca-Cola will begin US distribution of Coke Life, a stevia-and-sugar-sweetened mid-calorie version of its iconic Coca-Cola beverage. The launch comes after successful tests in Argentina. PepsiCo already distributes two similar drinks, Pepsi Next and Sierra Mist. However, those brands have been tarnished by accusations of false advertising and unnatural ingredients. If Coke Life's natural sweetener claim withstands health skeptics' scrutiny, it could be the answer to declining diet soft drink sales. This revelation would give Coca-Cola and PepsiCo a blueprint for the rest of their diet soft drink lines.

Coca-Cola and PepsiCo are also diversifying into non-soda categories. Bottled water, ready-to-drink tea, juice, and sports drinks are important parts of both companies' beverage portfolios. Coca-Cola derives about one-quarter of its total revenue from non-soft-drink beverages and PepsiCo derives more than one-third of its beverage revenue from non-soft drink beverages. These proportions will likely climb in future years, making them important contributors to overall growth. If soft drink innovations do not boost sales in 2015, investors should require strong sales of non-soda beverages if they want to hold onto their positions in these stocks.

Foolish takeaway
It's one thing to have a durable competitive advantage, and another to exploit it. Coca-Cola and PepsiCo own the best-selling brands in the soda universe, but have struggled to grow sales in the last couple of years. Although Foolish investors are long-term thinkers, sooner or later these companies need to perform. If Keurig Cold, Pepsi Spire, Coke Life, and other innovations cannot spark mid-single-digit volume growth in 2015, investors should reevaluate the soda giants' durability in the beverage industry.

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Ted Cooper is a member of an investment club that owns shares of Coca-Cola. The Motley Fool recommends Coca-Cola, Keurig Green Mountain, 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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