Pepsi & Coke: 2 soda stocks with no pop

These soft-drink giants aren't worth a taste right now.

By InvestorPlace Feb 10, 2012 11:52AM
By Dan Burrows

Have the kings of carbonated beverages lost their fizz? PepsiCo (PEP) and Coca-Cola (KO) both reported Street-beating quarterly earnings this week, but shares in the soft-drink companies are languishing in 2012.

Maybe it's because both companies find themselves bottled up by higher commodity costs, less-than-robust global demand and unfavorable foreign currency effects.

Neither Coke nor Pepsi dares to raise prices much and pass higher costs on to consumers. Not when they're locked in a market-share battle, when folks are increasingly opting for healthier snacks and beverages, and when the weak global economy makes their brand names more and more of a discretionary purchase.

But higher costs for juices, sugar, corn-based sweeteners and packaging are squeezing margins. Coke said Tuesday that juices and sweetener will add up to $350 million in costs this year alone. And so, both companies have to fall back on a combination of expense cuts, share buybacks, dividend hikes and marketing investments to boost business -- and shore up share prices.

Pepsi said Thursday it will lay off 3% of its work force, or nearly 9,000 employees, as part of a plan to save another $1.5 billion by 2014. That's on top of a $1.5 billion restructuring already under way. Pepsi's move follows Coke's announcement Tuesday that it's targeting savings of up to $650 million by the end of 2015.

That's all well and good, but as the old saying goes, you can't cut your way to growth. With both companies' fundamentals constrained by higher costs, competition and a lack of pricing power, their shares' long-term valuations bear closer scrutiny than ever.

The broader market, as measured by the S&P 500, is up more than 7% so far this year on a price basis. But Pepsi is up less than 1% and Coke is off more than 2%. Fully valued shares look to be at least partly to blame.

By its forward price-to-earnings ratio, Coca-Cola trades essentially in line with its own five-year average, according to data from Thomson Reuters. The same goes for Pepsi. True, neither stock looks terribly expensive by forward earnings -- but they're hardly bargains.

Perhaps more troubling are both stocks' price-to-earnings-to-growth ratios. PEG measures how fast a stock is rising relative to its growth prospects. Theoretically, PEG helps a value investor know when a stock's price has gotten ahead of its future earnings potential. At 2.6, Coke's PEG represents a 32% premium to its own five-year average. Pepsi's PEG of 1.92 is about 13% higher than its own five-year average. Again, those are by no means bargain valuations.

Wall Street's median price targets make much the same case on shares. Neither Coca-Cola nor Pepsi looks particularly overpriced -- they're just not all that cheap, either. Coke's median price target stands at $75. Add in the 2.7% yield on the dividend, and the stock has an implied upside of not quite 13% in the next 12 months or so. That makes the stock more of a hold than a buy for a lot of stockpickers. Pepsi looks about the same. Take a median price target of $71, add in the 3.1% dividend yield, and you get an implied upside of about 14% -- even after Thursday's selloff.

Bottom line: Based on analysts' average forecasts and relative valuation, neither Coke nor Pepsi looks particularly compelling at current levels.

Warren Buffett famously watched Coca-Cola for more than 50 years before initiating a position. Would-be investors in Coke and Pepsi needn't wait decades -- but they'd probably do well to wait for better entry points in both stocks. And current shareholders in Coke and Pepsi might need to employ some Buffett-like patience for market-beating returns.

And, if you don't have that sort of willpower, you can always look to other stocks Warren Buffett has found just as refreshing. Check out these seven Warren Buffett stocks dishing up double-digit gains.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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