PepsiCo and Coca-Cola Downgraded: What You Need to Know

Citing high valuations, this banker chooses Door No. 3.

Rich Smith
Rich Smith
Jun 7, 2017 at 12:19PM
Consumer Goods

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

For months, the rumors have been circulating: Will Kraft Heinz Company (NASDAQ: KHC) buy PepsiCo (NASDAQ:PEP)? Will Anheuser-Busch InBev step up and put Coca-Cola Company (NYSE:KO) investors out of their misery?

If you ask Canadian banker BMO Capital, it doesn't matter at all. Either way, you should not buy Coke or Pepsi -- either one. Here are three things you need to know.

Sugar pouring out of soda can

According to this analyst, no amount of sugar can make Coke or Pepsi stocks taste sweet. Image source: Getty Images.

1. BMO's not impressed with Pepsi (anymore)

Early this morning, BMO Capital announced it is downgrading PepsiCo stock from outperform to market perform. This move comes about eights months after BMO reiterated its positive rating on the stock (and set its $120 price target) -- a target that's nearly been achieved now, with Pepsi stock up close to 10% since BMO picked it.

Of course, now that this target is within striking distance, and with the prospects of "transformative M&A unlikely," the logical thing to do is declare victory and go home -- and that seems to be what BMO is doing.

Back in September, BMO said it liked Pepsi's "solid revenue growth" and "favorable operating leverage." The analyst predicted that PepsiCo's "earnings momentum is poised to continue," and indeed, that's just what we saw when Pepsi last reported earnings featuring only a 1.6% growth in revenue -- but a 41.6% increase in profits per diluted share.

Problem is, over future quarters and years, most analysts agree that Pepsi won't be able to maintain that pace. In fact, according to analysts quoted on S&P Global Market Intelligence, Pepsi's long-term earnings growth will average a mere 7% annually over the next five years. With PepsiCo stock selling for more than 25 times earnings, BMO is right to head for the exits.

2. BMO doesn't want a Coke and a smile, either

BMO is similarly less than enthused about Coca-Cola stock, which it is also cutting to market perform, this time with a $46 price target. Long-term, BMO says it likes Coke's prospects. However, at a P/E ratio of 32, Coke stock sells for a 27% premium to Pepsi, and BMO says Coca-Cola stock is near "peak valuation." (Indeed, at $45.61 per share, the stock is within just pennies of its 52-week high.)

From a valuation perspective, the case here is even clearer than what we see at Pepsi. If PepsiCo stock is not worth buying at 25 times earnings and a 7%-ish growth rate, then Coca-Cola stock -- at 32 times earnings and a long-term growth rate estimated at just 6% -- looks even less attractive.

Once again, BMO appears to be right on the money in downgrading this stock.

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3. The pause that refreshes?

So if not Pepsi, and not Coke, what food and beverage stocks should you buy? If you ask BMO, Dr Pepper Snapple (NYSE:KDP) stock is worth a look. At 20.5 times earnings, it's cheaper than either Coke or Pepsi. Plus, according to S&P Global data, analysts expect Dr Pepper Snapple to outgrow competitors quite handily in the earnings race. Analysts today estimate that Dr Pepper Snapple will post an earnings growth rate nearly 10% over the next five years.

While this hardly makes for an attractive PEG ratio (it actually works out to a PEG ratio of 2.1), 20.5 times earnings on 9.75% growth still makes Dr Pepper Snapple a much cheaper soft drink company to own than either Coke or Pepsi. Plus, as reported on (requires subscription) this morning, BMO has a hunch that Dr Pepper management is playing it conservative on its earnings guidance. The more Dr Pepper can outperform a 10% rate of growth, the better a buy this stock will become.