One could argue that the soda industry's best days are in the past. After years of rapid growth, which eventually made them among the world's biggest companies, The Coca Cola Company (NYSE:KO) and PepsiCo (NASDAQ:PEP) have seen growth level off.
Soda industry research firm Beverage Digest calculated that U.S. soda sales fell nearly 1% in 2014, representing the 10th consecutive year of declining sales. A decade-long decline in sales is more than just a passing trend; rather, there appears to be a more fundamental, long-lasting evolution in consumer attitudes in place.
Fortunately for PepsiCo's shareholders, the company isn't taking this lying down. It recently unveiled a major revamp of its flagship soda products. While this may take some die-hard Pepsi fans by surprise, PepsiCo's new sodas represent a major strategic step forward.
Craft soda on the way
PepsiCo has announced a new brand of craft soda called Stubborn Soda.
The lineup includes six sodas that are made with natural flavors and include no high-fructose corn syrup, the sugar substitute that often gets criticized by consumers. The flavors include black cherry with tarragon, root beer, lemon berry acai, agave vanilla cream, orange hibiscus, and pineapple cream.
These new sodas are set to hit food service customers in certain regions as early as this summer. Furthermore, the company is removing aspartame from Diet Pepsi, after sales of that product fell 5% last year.
Beverage Digest also reported earlier this year that Pepsi overtook Diet Coke to become the No. 2 soda in the United States. But that's a hollow victory for PepsiCo, as Coca-Cola and PepsiCo continue to battle for share within a shrinking market. Pepsi's case volume fell 1.4% last year, and 1% in the first quarter of 2015.
It's high time for the major soda companies to recognize what's happening right under their noses. Consumers simply aren't buying soda the way they used to, and this is particularly true when it comes to younger consumers.
Coca-Cola's response has been to invest in new products, such as tea, as well as to take a significant 16% stake in Monster Beverage Corporation. However, Coca-Cola has so far not made any changes to Coke or Diet Coke, which is the bigger issue at hand. Sparkling beverages still make up the majority of Coca-Cola's revenue and profit.
That's why I prefer PepsiCo's response. Not only is it investing in new products -- in fact, PepsiCo has 22 brands that each collect at least $1 billion in annual sales -- but it's also addressing the problem of falling soda sales at its core.
Because of this, I view PepsiCo's craft soda product as a no-brainer. If the concept fails, it won't cost the company much, and it's at least worth a try, given the broad declines in soda sales. On the other hand, if consumers embrace the product, PepsiCo could have a huge winner on its hands, as it could move quickly to distribute Stubborn Soda in can and bottle form.
Still betting on PepsiCo's future
PepsiCo is still a worthwhile investment. It's a highly profitable company, rakes in a lot of free cash flow, and returns a lot of that cash to investors.
PepsiCo generated $7.6 billion of free cash flow in 2014, up 11% from $6.8 billion the previous year. And according to the company, during the past decade, PepsiCo returned more than $60 billion to shareholders in combined dividends and share repurchases. This year, PepsiCo expects to return $8.5 billion-$9 billion to investors.
One way that PepsiCo plans to keep growing free cash flow is by continuing to build its massive portfolio of popular brands. In recent years, PepsiCo has embraced the trend toward healthier food and beverages, through 'good-for-you' brands like Naked and Sabra.
But these businesses won't be enough to save PepsiCo in the event consumers make a more permanent, structural shift away from soda. This is the reason why PepsiCo is getting proactive with its new Stubborn Soda product, and investors should give management credit for getting in front of the issue and responding to changing consumer behavior.