Rule Maker Portfolio Is Pepsi Beating Coke?

Pepsi has been hitting on all cylinders lately. The company has been beating cola king and Rule Maker holding Coca-Cola to the punch when it comes to identifying and exploiting expanding opportunities. With slowing growth in sugary carbonated beverages, Pepsi looks to be the company best positioned to prosper in the long term, while Coca-Cola's management apparently can't pick a direction.

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By Zeke Ashton
December 15, 2000

As you most likely already know, our Rule Maker beverage company, Coca-Cola (NYSE:KO), walked away from an acquisition of Quaker Oats (NYSE:OAT) in the 11th hour two weeks ago, only to see competitor PepsiCo (NYSE:PEP) snap up the oatmeal giant a few days later with an offer valued at about $13.5 billion.

This got me to thinking about Coca-Cola. We've been holding Big Red in our portfolio since February 27, 1998, when we dropped $1,865.89 of Tom Gardner's cash into the stock. As of last night's close, Coke has rewarded us with an investment loss of more than 17% in just under three years.

In the meantime, our Foolish colleagues in the Drip Portfolio researched the food and beverage industry and selected PepsiCo. In choosing Pepsi over Coca-Cola (and many other companies in the food and beverage industry), the Dripheads reasoned that Pepsi has more options to grow its business. Jeff Fischer referred to these growth options as levers. Here in the Rule Maker Portfolio, we call them expanding possibilities.

Those Drip guys may be on to something. They may be funny looking, but Dripmeisters Jeff and Brian have always emphasized expanding possibilities in their investments. Expanding possibilities for growth is of paramount importance when considering making a long-term commitment to a company. Here in the Rule Maker Portfolio, we like to invest in companies with an eye on the long term, too, and sometimes maybe we spend too much time looking at the current location of the business and not enough at the future direction.

Coca-Cola is still a very strong Rule Maker, and likely always will be. But as Pepsi's momentum has increased, Coke's fundamentals have decreased. Pepsi's stock has jumped 38% in value over the past three years, and while that's certainly nothing to write home about, it's a lot better than losing one-sixth of your investment, as we have in Coke.

In the last year or so Pepsi has really stepped up the pace. Of course, the company isn't just about soft drinks. In fact, Pepsi products account for only 25% of the company's sales. Frito-Lay is the world's number one salty snack food maker, and accounts for 63% of PepsiCo's sales. Tropicana, PepsiCo's fruit juice unit, accounts for another 11.6% of sales, and is the world's leading producer and marketer of branded fruit juices. Pepsi is the world's number two carbonated soft drink, behind Coca-cola.

But with worldwide sales growth of carbonated beverages slowing, the growth lately has been found in non-carbonated beverages such as bottled water, teas, sports drinks, energy and health drinks, and ready-to-drink coffee. Pepsi has really chased these growth opportunities. It owns the number one brand of bottled water in the U.S., Aquafina, and it owns Lipton, the number one brand of ready-to-drink tea. Pepsi also sells Frappuccino in partnership with Starbucks (Nasdaq: SBUX), which now happens to be the number one ready-to-drink coffee beverage in the United States. 

While Coca-Cola has moved into bottled water (with Dasani) and into the sports drink market (with Powerade), Coke is clearly behind Pepsi in gaining traction in these segments. In October, Pepsi acquired South Beach Beverage Company, whose SoBe brand of bottled beverages has been a hit in the so-called "non-carbonated alternative" category.  SoBe sells energy drinks, teas, and other beverages with herbal ingredients such as Gingko Biloba and St. John's Wort.

With the Quaker Oats purchase, Pepsi now adds Gatorade, the dominant sports drink on the market, to its portfolio of brands. Gatorade owns something like an 80% market share in the sports drink market, and neither Coca-Cola's Powerade or Pepsi's All-Sport has been able to pry customers away from the Gator. Gatorade has an especially powerful brand outside the United States; on my last trip to Europe, Gatorade was available in every gas station I stopped at in both Germany and Italy. Powerade and All-Sport were not. 

Here's the worst part. According the Wall Street Journal, Coca-Cola negotiated to buy a stake in SoBe for months. Pepsi swooped in and scooped up the company while Coca-Cola has to keep looking for a way to fill a hole in its product lineup. And with Quaker, Coke CEO Doug Daft had all but done the deal. They had even shot publicity photos. All that was left was for Daft to convince Coca-Cola's board that the acquisition was the right thing to do. He couldn't. Coca-Cola's board, which includes Berkshire Hathaway (NYSE: BRK.A) Chairman and investing legend Warren Buffett, apparently felt that the price for the acquisition was too high. Complicating matters was what to do with Quaker's lower-growth breakfast cereal products -- Coke isn't in the food business. The company could have sold the non-Gatorade businesses, or spun them off to investors, but in the end, Coca-Cola just decided that it wasn't the right deal.

Pepsi, on the other hand, has no such issues. Quaker is as close to a perfect match for Pepsi as it gets. Gatorade will help Pepsi immensely, and the Quaker breakfast foods and snacks might make a nice complement to Pepsi's snack food business. In the end, though, in both the SoBe and the Quaker purchases, Pepsi showed that their management knows what it wants and is able to move quickly and efficiently when opportunities present themselves. With all of these great brands and a large portfolio of products, Pepsi is doing all it can to create opportunities for growth within the slow-growing food and beverage industry. With the Quaker and SoBe acquisitions, the company has more expanding possibilities than ever.

Coca-Cola's boardroom dilemma is symptomatic of a management that can't achieve unity on the proper direction, and can't act quickly or decisively to take advantage of opportunities. There is no question that Coca-Cola has "good" managers. Warren Buffett is one of the best businessmen and investors of our time. And I've been impressed with the moves Douglas Daft has been making to pull Coke out of its recent funk. But when good managers can't agree on the direction a company should go, well, that's no longer good management. 

If you are interested in a comparison of Coke's Rule Maker financials versus that of Pepsi combined with Quaker, I've posted the numbers on the Rule Maker Companies discussion board.

Finally, if you are interested in investing ideas from the food and beverage industry and 16 other industries, I invite you to check out our 2001 Industry Focus! It's 192 pages of industry analysis and Foolish investment ideas. 

Have a great weekend!


Rule Maker Portfolio

12/15/00 as of ~8:30:00 PM EST

Ticker Company Price
Daily Price
% Change
AXPAMER EXPRESS(0.81)(1.47%)54.63
CSCOCISCO SYSTEMS(2.78)(5.46%)48.16
INTCINTEL CORP(2.69)(7.65%)32.44
JDSUJDS UNIPHASE CORP(3.34)(5.44%)58.16
KOCOCA-COLA CO(3.50)(6.14%)53.50
MSFTMICROSOFT CORP(6.31)(11.37%)49.19
NOKNOKIA CORP ADS(1.75)(3.62%)46.63
PFEPFIZER, INC(0.13)(0.27%)45.44
TROWT.ROWE PRICE ASSOC(0.31)(0.78%)39.94
YHOOYAHOO INC1.003.13%33.00

  Day Week Month Year
To Date
Rule Maker(4.03%)(6.36%)(2.73%)(29.66%)14.63%4.75%
Comparable S&P 500n/an/an/an/a19.95%6.38%
S&P 500(2.15%)(4.21%)(0.21%)(10.69%)34.29%10.54%
S&P 500 (DA)(2.12%)(4.16%)(0.21%)(10.57%)36.07%11.03%

Trade Date # Shares Ticker Cost/Share Price Total % Ret

Trade Date # Shares Ticker Total Cost Current Value Total Gain

The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.