Coca-Cola (KO, Financial) has been one of the great success stories among consumer staple stocks. Its performance throughout its long history has been consistently strong thanks to an excellent brand image and capital allocation, and its dividend has made it a top choice for many income investors.
This year's possibility of a recession has many investors seeking safer investments. Coca-Cola has traditionally been seen as a safe haven for investors, providing reliable returns even during economic uncertainty. In addition, Coca-Cola has earned the title of Dividend King, having increased its dividend for 60 consecutive years. This impressive streak is a testament to the company's commitment to long-term growth and stability.
However, there are a few factors that I believe could hurt Coca-Cola's investment potential. In particular, I'm concerned about how well it can stack up against rival PepsiCo (PEP, Financial). With Coca-Cola's upcoming price hikes and Pepsi's greater diversification, could Pepsi have the advantage in a recessionary environment?
Price hikes: A double-edged sword
The beverage industry is not immune to the economic realities of rising prices due to inflation and other key factors. Inflation has increased unit costs, which can be a major challenge for beverage companies.
The international carbonated drinks market is dominated by a few major global players, of which Coca-Cola and Pepsi are two, giving them leverage to raise prices without facing substantial backlash from customers. However, even the giants still have to be careful not to hike prices too fast and drive away customers.
Coca-Cola recently announced that it would increase soda prices in 2023 despite Pepsi planning on holding off on further price increases for now. Both companies are attempting to increase sales but have taken separate approaches - Coca-Cola with price hikes and Pepsi with stagnating prices to keep volumes high.
Throughout 2022, Coca-Cola's average selling price went up 11%, while Pepsi's average selling price growth was even higher, at 14%. James Quincey, the CEO of Coca-Cola, recently affirmed that the company would keep increasing prices globally in 2023, though it will be less intense. Compared to its main rival Pepsi, Coca-Cola actually opted for fewer price increases over the last year, allowing it to gain an edge, but now that it's raising prices more aggressively this year, I think the ball will move into Pepsi's court.
In the fourth quarter, Coca-Cola's net sales rose just 7% to $10.13 billion, which fell short of its price hikes. Thus, investors cannot ignore the warning signs. The company's unit case volume dropped 1% in its fourth quarter, not considering currency or price differences.
Last quarter, Coca-Cola noted that in the EMEA (Europe, Middle East & Africa) region alone, the sales unit value was down by 5%. Quincey mentioned that European buyers are feeling the effects of high inflation.
If inflation remains high, Coca-Cola's production costs will continue to increase significantly, thus affecting the bottom line. As a result, its top-line growth is likely to take a hit. Last year it was able to combat these costs, but with the current inflation levels, it could become difficult to maintain robust sales volumes alongside regular price hikes.
Diversification gives Pepsi an edge
Although Coca-Cola and Pepsi are often considered competing brands, Coca-Cola is more beverage-focused while Pepsi also owns snack brands.
Coca-Cola not only sells carbonated beverages but also offers a wide variety of other drinks that can be purchased in stores. It has a diversified portfolio of drinks, from the iconic original Coca-Cola drink to flavored sodas like Fanta and Sprite and energy drinks, juices and teas. It also produces a range of low-calorie and no-sugar options for healthier alternatives.
Pepsi also sells a variety of carbonated and non-carbonated beverages, including Gatorade and other licensed brands, but one of its primary sources of diversification is its Frito-Lay subsidiary, which produces snack foods. It also produces packaged food through its Quaker and Pioneer food subsidiaries.
This greater diversification provides greater protection against economic downturns in my view. Additionally, during the early days of the pandemic, Pepsi was able to offset headwinds in beverages by selling more packaged foods through busy grocery stores. That is why when organic revenue growth fell 9% in 2020 for Coca-Cola, PepsiCo finished the year with growth of 4%.
Notably, Coca-Cola's earnings per share without non-recurring items growth rate stands at a meager 1.90% for the past three years compared to an impressive 7.30% for Pepsi.
A growing dividend, but at a price
Investing in stocks should never be done based on dividends only. However, Coca-Cola has a long history of increasing its dividend payments, so the dividend is a major consideration for investors in the stock.
As of this writing, Coca-Cola has an impressive dividend yield of 2.99%. In addition, Coca-Cola is a Dividend King, having increased its dividend for 60 consecutive years. This impressive streak of growth shows the reliable and enduring success of the company. Pepsi is also a Dividend King with a dividend yield of 2.63%.
However, there is one area where investors might find a major difference in these two companies, and that's in the dividend payout ratio. The dividend payout ratio is calculated by dividing the total amount of dividends paid out in a given period by the company's total net income for that same period. This ratio can be used to gauge how much of its earnings a company is returning to shareholders. We don't want it too low for obvious reasons, but we don't want it too high either as it might be unsustainable.
The dividend payout ratio for Coca-Cola is at 0.8, while Pepsi has a slightly lower rate of 0.7. I'd say Coca-Cola has limited leeway to raise dividend payments versus its competitor, making it tough for investors to expect bigger returns.
While evaluating their dividend growth rate over the past three years, it is evident that Pepsi also holds the edge here. Its dividend growth rate is 6.10%, while Coca-Cola's is just 3.20%.
Takeaway
Coca-Cola and Pepsi both rank high on the Dividend Kings index, and both have historically been reliable consumer staple giants. However, which one has the advantage in the current economic environment?
I believe having a more diversified portfolio makes Pepsi a better prospect at the moment. Coca-Cola also has a slower growth rate and a higher dividend payout ratio, which means it does not have as much space for future dividend hikes. Finally, Coca-Cola plans to raise prices this year while Pepsi plans to hold off, which should give Pepsi an edge in 2023.
