Sodas definitely aren't a growth market. Industrywide sales have fallen annually for 10 straight years due partly to rising concerns about the health effect of sugary drinks. Yet that doesn't necessarily mean that soda stocks are bad investments.
Over the past five years, shares of Coca-Cola (NYSE:KO) and PepsiCo (NASDAQ:PEP) have risen over 50%, while shares of Dr Pepper Snapple (NYSE:KDP) have more than doubled. What do these soda companies having going for them?
Coca-Cola's full-calorie Coke is the top-selling soda in the world. It also owns top soda brands like Sprite and Fanta.
To compensate for lower demand for carbonated drinks, Coca-Cola shifted toward two main strategies over the past decade. First, it diversified its portfolio with "healthier" drinks like zero-calorie sodas, Minute Maid juices, NOS energy drinks, teas, and Dasani bottled water. Second, it bought Coca-Cola Enterprises' North American bottling operations in 2010 to streamline its supply chain. Both moves strengthened Coca-Cola's top and bottom lines, though that growth flattened out between 2011 and 2014, when annual sales only rose 1%.
Last quarter, Coca-Cola's revenues and operating income fell across all geographic regions except North America due to mixed demand and currency fluctuations, resulting in a 3% annual decline in net revenues. However, net income improved 19%, thanks to price hikes in North America.
Coca-Cola also intends to cut costs by having two-thirds of its bottle/can volume in the U.S. distributed by independent bottling partners by 2017. But for now, Coca-Cola still isn't cheap at 24 times earnings, compared to the S&P 500's P/E of 21.
PepsiCo, which also owns 7-Up and Mountain Dew, doesn't just sell beverages, as Coca-Cola does. It also sells Frito-Lay snacks, Quaker oatmeal, and other food products.
Last quarter, Frito-Lay's North American revenue rose 2% annually and accounted for over a fifth of PepsiCo's top line. The division's operating profit climbed 7% and accounted for a third of its bottom line. That partially offset top- and bottom-line declines in its Quaker and Latin America food divisions. Going forward, PepsiCo investors should see if growth in these units can offset weak growth in sodas.
PepsiCo's Americas beverage business, its largest unit, posted 1% and 4% revenue and operating profit growth respectively last quarter. PepsiCo's total revenue, however, slipped 6% annually due to unfavorable exchange rates as net income remained flat.
Over the past few years, PepsiCo has diversified its beverages portfolio with non-carbonated alternatives like Starbucks' bottled coffee drinks, Tropicana and Naked juices, and Aquafina bottled water. It also bought its two largest bottlers in 2009. But just like Coca-Cola, PepsiCo's annual revenue growth has remained flat since 2011. PepsiCo stock is notably cheaper than Coca-Cola with a P/E of 22, but it still trades at a premium to the market.
Dr Pepper Snapple
Investors often overlook Dr Pepper Snapple, which was spun off of Cadbury Schweppes in 2008. But between 2011 and 2014, its annual sales rose nearly 4%, outpacing Coca-Cola's and PepsiCo's flat top-line growth. Net income also improved 16% during that period.
Dr Pepper Snapple has a similar mix of carbonated and non-carbonated drinks as its larger rivals. Its well-known brands include Mott's, Canada Dry, A&W, Sunkist, and the U.S. bottling rights to 7-Up. The company's products are mainly sold in the U.S., Canada, Mexico, and the Caribbean. This exposes it to currency fluctuations in Latin America, which accounted for 9% of its top line last year, but protects it from weak currencies in Asia, Europe, and other markets.
Therefore, investors concerned about currency headwinds might pick Dr Pepper Snapple over Coca-Cola or PepsiCo, which rely more heavily on those overseas markets. Dr Pepper Snapple also shines in terms of return on equity (ROE), which calculates how efficiently a company turns shareholder capital into profits. Its trailing-12-month ROE of 31.7% easily tops Coca-Cola's ratio of 22.8% and nearly matches PepsiCo's 32.8%. But like both rivals, Dr Pepper Snapple also trades at a slight premium to the market, with a P/E of 22.
The bottom line
Soda stocks definitely aren't high-growth investments. Declining demand for carbonated drinks and unfavorable exchange rates are casting doubts over their futures.
Yet these companies are constantly diversifying their brands to reach new customers. Coca-Cola's ability to offset sales declines with price hikes last quarter also indicates that soda makers can temporarily increase prices to protect their bottom lines, which could fuel dividend hikes in the future. Coca-Cola pays a forward annual dividend yield of 3.2%, PepsiCo yields 2.9%, and Dr Pepper Snapple yields 2.4% -- all of which are higher than the S&P 500's average yield of 1.9%.
However, investors should note that although these soda stocks look like conservative income stocks, they're currently trading at higher multiples than the market, which means that we could see lower prices ahead.