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Take a Soda and Watch These Beverage Giants in a 'BRIC War'
Posted by: Damian Illia (IP Logged)
Date: November 7, 2013 11:35AM

The U.S. beverage industry is divided into alcoholic and non-alcoholic beverages. The non-alcoholic segment includes carbonated soft drinks (CSDs), fruit beverages, bottled water, milk, sports drinks, energy drinks, nutritional drinks; tea and coffee products. Intensive competition surrounds this industry where companies are struggling to generate more volume outside the U.S. In this article, I will analyze the two major players in the Western world.

The Coca-Cola Company (KO) is the best global brand (in terms of brand equity) and the world´s largest producer of soft drinks. The company sells products in more than 200 countries and owns or licenses more than 500 brands. Sales by operating segment in 2012 were derived as follows: North America (45.1% of revenues); Bottling Investments (18.3%); Europe (9.3%); Pacific (11.6%); Latin America (9.5%); Eurasia and Africa (5.9%); and Corporate (0.3%).

International Long-Term Growth

The company can increase market share in Brazil, Russia, India and China (BRIC) where PepsiCo Inc. (PEP) is fiercely competing. Coca-Cola will boost its investments in China, where it is planning to invest $4 billion by 2014. Nowadays the company has 42 plants across the country and is going to open a new one in Shijiazhuang, at the North of China.

The firm also plans to invest $8 billion in Brazil and $3 billion in Russia by 2016. The focus is clearly on the BRIC countries to drive soft drink sales in markets where the consumption is relative low compared to other big countries. It is true that people all over the world, even in the most remote parts of developing countries, demand Coca-Cola. So I believe that volume growth during the following years will be led by those countries.

Good Chain

The firm's strategy is to use its brands and financial strength to achieve long-term growth. Additionally, it has created an extensive and well-organized global distribution system, which cannot be replicated by any of its competitors at least at a reasonable cost.

A Dividend Favorite

Looking at the financials, the company has a strong balance sheet: good cash that allows it to reward current shareholders through dividend and share repurchases. Dividend-payment history affirms its commitment to maximize shareholder wealth. In February 2013, the company raised its quarterly dividend by 10% to $0.28 per share from its earlier payment of $0.255 per share. Coca-Cola has raised its dividend each year in the last 51 years. Over the last year, the company bought back shares worth $3.1 billion.

Valuation

In terms of valuation, the stock sells at a trailing P/E of 20.6x, trading at a premium compared to an average of 20.5x for the industry. Analysts’ expectations imply a forward P/E of 17.71. To use another metric, its price-to-book ratio of 15.4x indicates a premium versus the industry average of 2.5x and the price-to-sales ratio of 3.8x is above the industry average of 1.4x.

The Soft-Drink and Snack Food Giant

PepsiCo is a leader in the global snack and beverage industry. The company is organized into three business units with six reportable segments: PepsiCo Americas Foods (PAF), which includes Frito-Lay North America (FLNA), Quaker Foods North America (QFNA), and Latin America Foods (LAF); PepsiCo Beverages America (PAB), which includes PepsiCo Beverages North America and all of its Latin American beverage businesses; and PepsiCo International, which includes all of PepsiCo businesses in Europe and Asia, the Middle East and Africa (AMEA).

On the Same Playing Field

PepsiCo focuses on BRIC countries to expand its market share, as they represent the fastest growing food and beverage markets in the world. For example, the company created “Pepsi Atom” exclusively for Indian consumers, a beverage that tries to address their need and desire for a stronger, fizzier cola with a sharp taste hit. If PepsiCo is successful, this product will increase its revenues and global market share significantly.

Offsetting Weakness

Snack success is making a big difference in the company's outlook. Earnings rose in the third quarter as strong sales in this segment helped the company to offset the decline in drink sales. In the future, the firm wants to shift its business mix from its current fifty-fifty to two-thirds toward snacks.

Its P/E multiple on a trailing-12 month basis is 19.8 and the forward P/E multiple is 17.97. The current dividend yield is 2.61%, which is quite good to protect the purchasing power.

Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.

Company ROE Compared to Industry Mean (=10.0)
Coca Cola 27.5 Above
Pepsico 27.6 Above

It is very important to understand this metric before investing in a high-growth company.

Final Comment

The profitability of the companies is driven by their ability to reach new markets and meet customer needs. Consumers around the world have become more health conscious and reduce their consumption of drinks that have large amounts of sugar, calories and fat. So, consumers have been steadily moving away from fizzy drinks towards healthier options such as juices and sports drinks. As soda consumption might be on the decline in North America, companies will now go head-to-head in high-potential regions.

For this reason, it seems like the right time to add Coca-Cola’s stock to your long-term portfolio. Hedge fund guru like Ray Dalio, Joel Greenblatt, Steven Cohen, Donald Yacktman and Jeremy Grantham added this stock to their portfolios, and I would advise fundamental investors to consider adding this stock to theirs as well.

Disclosure: Damian Illia holds no position in any stocks mentioned.



Guru Discussed: Donald Yacktman: Current Portfolio, Stock Picks
Jeremy Grantham: Current Portfolio, Stock Picks
Stocks Discussed: KO, PEP,
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