Is Pepsi better than Coke?

The soda maker appears better positioned than its larger rival to overcome the tough beverage climate.

By TheStreet Staff Aug 5, 2013 11:56AM

thestreet logoMale Stock trader copyright Flying Colours Ltd, Digital Vision, Getty ImagesBy Richard Saintvilus

 

A lot of questions were raised when shares of Pepsico (PEP) recently reached a new 52-week high of $87.06. Not only did this elevate Pepsi's year-to-date gains to 30%, but Pepsi investors have begun to proclaim how their stock is now running laps around Coca-Cola (KO), whose year-to-date gains have yielded "only" 15%.

 

I say "only" in this manner because I don't believe in discounting double-digit gains in any market. While it is indeed impressive that Pepsi, a stock that I've long believed was undervalued, is now doing so well, I wouldn't get carried away here just yet. But I will say that I believe that Pepsi has earned the right to be in the "front-line" or on the marquee. To say it another way, I'm not ready to declare that Pepsi has passed Coca-Cola, but after looking at Pepsi's second-quarter earnings results, I don't believe that Pepsi is still playing second fiddle to its larger rival.

 

With obesity concerns plaguing soft-drink companies, it hasn't been a great year for the industry as most companies, including Coca-Cola and Dr Pepper Snapple (DPS), posted significantly less volumes in the second quarter. But unlike Coca-Cola and Dr Pepper Snapple, which posted revenue declines of 3% and 1% respectively, Pepsi managed to grow revenue by 2% year over year, which beat Street expectations.

 

Even more impressive was that when looking at Pepsi's report on an "organic basis," which focuses solely on the company's internal operations, revenue growth was closer to 4% year over year. But it wasn't all good news. "Liquid candy." a term used to describe soda and other carbonated sugar-filled beverages, is at the top of the list of those trying to bring nutritional awareness to the obesity dilemma -- a disease impacting close to 40% of Americans.

 

One of the ways that Coca-Cola has tried to augment its nutritional profile is by introducing a product called Coca-Cola Life, a new drink that uses a blend of sugar and Stevia, a plant-based sweetener that has no calories. But we've been down this road before with Coke Zero. This does not mean that Coca-Cola Life will suffer a quick death.

 

Still, there's enough data to suggest that new low-calorie alternatives -- although healthier -- are never as popular as the original product they try to replace. Coca-Cola's 4% volume decline in North America implies that these sorts of efforts, while noteworthy, won't be enough to offset weakening sales. Dr. Pepper Snapple, which posed 3% decline didn't perform any better. Neither was Pepsi, meanwhile, did even worse -- declining by 5%. It's an unfortunate reality.

 

But here's the difference. On an organic basis, Pepsi's decline was closer to 1%. While the nutritional fears have caused an anemic performance in Coca-Cola's beverage business, which was up 1.5%, Pepsi's volume was up 3%. What's more, in areas like Europe and the Asia/Mideast/Africa regions, Pepsi was able to post organic growth of 4% and 14% respectively. By contrast, Coca-Cola experienced a 4% decline in Europe.

 

But even with these contrasting results, I still believe it's premature to say that Pepsi is better than Coca-Cola. If there's a question to be raised, it's with what seems to be Pepsi's impressive ability to navigate the public's worries about increased calories. Clearly, within its product mix, Pepsi's management has not only figured out ways to offset weak volumes, but in the process, the company has reversed what has ordinarily been a struggle with profitability.

 

Not only did management grow margins by 110 basis points, but the year-over-year improvement was almost twice what the Street was expecting. This and solid expense control led to a 10% year-over-year improvement in operating income. In that regard, I don't believe it's still fair to discount this level of performance. To the extent that this has propelled Pepsi beyond Coca-Cola, I'm still not ready to make this claim.

 

Here's what I do notice: Pepsi has spent the past several decades on acquisitions; many of which has been food companies, including the likes of Frito-Lay and Quaker Oats. In the recent quarter, these two brands (among others owned by the company) helped Pepsi to amass over $6 billion in revenue. Of that $6 billion, $1.36 billion was all operating profits, or 43% of the company's net income.

 

From an investment perspective, I believe there's still plenty of value in Pepsi's food business, which has been feeding the company's growth while the beverage business get its act together. What this means is that Pepsi is well diversified and the company is not going to "drink" itself out of business, even as global soda consumption remains under pressure.

 

From that standpoint, I believe Pepsi is indeed better positioned than Coca-Cola to overcome the tough beverage climate, as Pepsi has already demonstrated. And with no signs of slowing down and free-cash-flow growth expected to remain in the double-digit area over the next 5+ years, I can see fair value in the stock approaching $92 per share, which makes Pepsi a better buy at this level than Coca-Cola.

 

At the time of publication, the author held no position in any of the stocks mentioned.

 

 

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4Comments
Aug 5, 2013 2:18PM
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We prefer Pepsi, both the beverage and the stock, much more diversified product line, maybe less in the soft drink sector but the wider range of snack foods and Quaker Oats etc, so far seems like a good long term plan that pays a steady dividend plus appreciation in value.
Aug 5, 2013 12:56PM
Aug 5, 2013 3:38PM
avatar
till they take the high fructose corn syrup out of the pop, there not be any in this house. there a hole list of junk that not in this house because of the HIGH FRUCTOSE CORN SYRUP. So best of luck, on that one, more and more people now know of how your poison then for the Dollar.
avatar
Pepsi used to carry the name "Pepsi Cola" back in the 70s and 80s,but Coca Cola lodged a petition and Pepsi Cola had to change "Pepsi Cola" for "Pepsi.I gave up drinking pop soda ever since I felt a sharp pain in my kidneys one time.pop sodas are detrimental to one's kidneys especially as we grow older.if you want to have healthy kidneys as you age,drink just plain water,I mean just plain water and nothing mixed with it.vitamin waters and energy drinks are no good either.WATER,WATER,WATER!  
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